Second wind for DeFi’s golden oldies?

Risk and value boys. Dispersion has been this cycle’s calling card. Instead of everything ripping upwards like a crack-fueled chimera, investors are assigning individual ratings to assets.

This is net bullish, if you think about it.

Dreadful for you if you are a mid-curver, but excellent if you are a retard with no sense of risk… or if you’re smart. Balls or brains are the only way to make it here, lads.

Market confluence points to a select handful of the old guard breaching the “value” segment if you want to call it that.

Time for Pango to flesh out a DeFi revival thesis. Say goodbye to cucked “governance tokens” and say hello to chad “cash-flowing assets.”

Year-to-date performance paints a wicked picture depending on where you have deployed capital.

BTC-SOL-Meme barbell remains absolutely undefeated. RIP all the Cosmos boys.

But you will see an interesting middle ground emerging: DeFi blue chips on Ethereum. And that today, boys, is where we will be focusing our attention.  

Short Form Thesis: Change in regulatory climate sees DeFi OGs flip fee switch -> people bid. Welcome the new age of cash-flowing assets, baby.

Why DeFi? Why now?

A changing regulatory climate opens the door to a whole new paradigm. Anything with a proven lindy, product market fit, and decent revenue is fair game for a repricing. The DeFi OGs can now be fairly valued with traditional methods and the numbers being spat out are looking good.

The lynchpin of the thesis is that we are going to see tokenomic overhauls introducing revenue capture for token holders. Either through buyback and burns or revenue share.

Preference for:

• Buyback during bear market due to thinner books
• Revenue share during bull markets because people have lizard brains for yield- case in point, the fixed-income market is larger than the global equities market

Markets have consistently shown that they prefer free-market pricing with a fully circulating supply. Nobody wants to buy ‘VC coins’ with complicated tokenomics designed to fleece you of your dollars and put them into a VC’s pocket.

Any token with parity between FDV and market cap is worth observing, aka the DeFi old guard.

Trad money is swooping into the best parts of the space (from a value perspective).

Observe ETFs. Natural that typical valuations hold more clout as the investor base increasingly shifts towards tardfi-types (who get hard over discounted cash flows).

But this “tardfi will buy my bags” thesis only applies sparingly (but, I do thoroughly believe Pendle is included here). Pango is horny for Aave, flat Uniswap (fuck Hayden) and Compound, and cautiously optimistic for MakerDAO.

Please account for personal basis, Pango loves DeFi because it directly challenges the structural control governments possess over finance.

Note that on August 5th, Charles Schwab, TD Ameritrade, Vanguard, E-Trade, and Fidelity went down, but DeFi continued functioning as normal. Shout out smart contracts.

Betting on a growing shift towards fundamentals (and despite fucking dogshit price action of ETH) Ethereum is meaningfully plugged into the tardfi capital spout and should carry this movement.

‍DeFi protocols meaningfully revamp tokenomics -> value flows to token holders -> the tokens pamp as a result.

Ideal business model

In a perfect world, all protocols should operate like the diagram below. At the basest of levels, they are multi-sided platforms allowing different agents to interact.

Supply side offers a service (typically liquidity), demand side pays for the service, and token holders capture a portion of this payment. In reality, tokens are used for liquidity bootstrapping, letting founders cash out, and driving attention through speculation.

By the time revenue capture is introduced for token holders, capital is typically not needed. The app has been bootstrapped, the founders are racked up and racked out, and the token has been distributed. But less skepticism and more appreciation that we finally have valid business models working as intended.

Aave: Finnish ghost getting fat

Business Model: Interest Rate Spreads, Flash Loans, Liquidation Fees

Aave perfectly exemplifies what makes DeFi great. It is the leading heavyweight in the lending space and a protocol we should all be familiar with. Pango’s personal favorite for the great DeFi senior repricing.

The spotlight is currently all up in Aave’s grill thanks to two key proposals: Umbrella and AAVEnomics.

Aave is getting a full facelift. Big improvements in protocol security and functionality and looking to share shekels with token holders. Hard not to be excited.

$AAVE Overhaul: Umbrella & AAVEnomics

Right, let's hit a whistlestop tour to extract the good bits without getting bogged down in the nerd shit.

Umbrella is wicked cool. No two ways about it. In essence:

1. Umbrella applies a similar philosophy of isolated markets to security
2. Uses a match-and-burn strategy to sidestep reliance on secondary liquidity
3. Opens the idea of Aave selling security services (like insurance) via re-staking.

Currently Aave’s protection against bad debt is the Safety Module. Token holders lock their AAVE tokens in the contract and in the event of a shortfall, these tokens get auctioned off.

In short, stake AAVE for yield (security payments) and in the event of bad debt, stakers eat the downturn. (Poor design overall; when they need to use the funds, likely post-period of extreme volatility, the last thing you want to be doing is dumping thick wads of AAVE into thin bids.)

‍Umbrella is a totally new approach. Instead of using $AAVE, it will leverage aTokens (interest-bearing derivative tokens minted and burned at deposit/receipt when you deposit into Aave) to cover bad debt.

No more governance votes on what constitutes a shortfall event. Instead, pre-set rules with automatic slashing (faster and more efficient). Each network has its own Umbrella, meaning those providing security only do so for their own network (good lever to ensure risk and rewards are fairly aligned).

The first suggested collateral tokens are awETH and aUSDC, which will be first in line to get burned on the network where deposited in the event of a shortfall. Rewards are also dynamic, curbing overspend on security.

‍The debt is directly covered. Instead of selling AAVE to cover it, the corresponding number of aTokens are burned. Super simple but bloody marvelous - totally cuts out reliance on secondary liquidity. No losses related to slippage and avoids having to turbo-dump AAVE in extreme periods (unreal psychological gains for holders).

Importantly, Aave is segmenting off security. Each network covers itself, GHO is treated as an entirely separate product, and depositors can juice their yield. Not to mention, Umbrella re-staking opens a whole new can of worms for future Aave revenue.

What about AAVEnomics?

This is the fee switch segment gentlemen.

This proposal is hella long-winded, dives into a bunch of shit, and overall reads like chewing overcooked sticky toffee pudding. But just like that pudding. Boy, is it sweet.

All we need to know is that $AAVE will become a yield-bearing asset, with each staker entitled to a portion of the revenue generated by Aave.

When will all of this happen? Mr. Zeller believes by end of year and trigger conditions are as follows:

• Aave net holdings are at twice yearly service provider’s recurring costs for the past 30 days
• Aave 90-day annualized revenue is at 150% of all protocol expenses year-to-date

Hit these two metrics and sweet shekels start to flow to staked Aave enjoyers.

Look at how fucking confusing this shit is man. All you need to know is this:

• Staked AAVE earns protocol revenue
• Staked GHO earns yields for protecting against bad GHO debt
• Staked aTokens will be used for security against bad debt and earn extra yield

High level is that security is improving, secondary markets are getting cut out thanks to the match and burn approach, depositors can gronk extra yield for security services, everything is segmented and compartmentalized, and AAVE stakers will be sharing protocol earnings absolutely analogous to a dividend payment.

• Capital efficiency increased. Check.
• Tighten up governance against potential attacks. Check.
• New revenue stream from Umbrella re-staking. Check.
• Sunset LEND. Check.
• Segment deposit and GHO activity. Check.
• Unlock ability to juice deposit yield. Check.
• Give AAVE holders shekels. Check.

It is a full-on facelift lads.

Dividend estimates

Is this really crypto? A protocol that is profitable following a very standard business model that now plans to share revenue with users. Fucking send it.

Every gay lord touting a copy of The Intelligent Investor can now bid Aave using discounted cuck flows and P/E (price-to-earnings) ratios. Bet it comes out way ahead of the bulk of layer ones.

But how much will this revenue share be worth?

‍

Numbers don’t lie, boys. Aave is printing. Time to rip some napkin maths.

Take the trigger conditions, run the numbers, sprinkle in a light bit of guesswork for predicted figures. And hey presto we get an estimate.

Yield to stakers with current figures nets you roughly 4% - remember, yield gets diluted as more stakers dive in.

Activate the ‘earn yield and benefit from an appreciating price driven by fundamentals’ narrative. Warren Buffett himself could value Aave and tell you if he would own the stock.

Let the games begin. Remember, everything in finance is a fugazi to lure somebody else in to buy at a higher price.

But the current Aave playbook is one intoxicating beverage for even traditional investors. Don’t forget the implicit warning that should be attached to every financial instrument: ‘As long as you sell in time.’

Shout out Aave for running the marathon. Protocol with sustainable yield and sharing revenue with holders. This is what it is all about. Stepping into this territory is very important for the space long term. Bullish from a value perspective on a high time frame.

Remember that once one does it the rest have to do it. Lending and borrowing market with a dividend payment for token holders. TradFi investors nursing an erection, and they don’t even know it.

Uniswap: DEX paradise or parasite?

Business Model: Frontend fees, jeeting tokens, raising equity

Uniswap. The OG on-chain trading house. Beautiful piece of tech. Fundamental contribution to the space. And overall still an absolute beauty.

Truly a pioneer and put some respect on the name. Happy to be wrong but believe Uniswap is a classic example of “excellent protocol, shitty token”.

Even the origin of the UNI token was a hack job aimed to draw back liquidity after SushiSwap (RIP) vampired them back in the day. Paraded as an attempt to ‘decentralize’ governance.

Don’t forget that Uniswap also did the equity and tokens split. Totally rubs me the wrong way and sets a horrific precedent. Guess what, fiduciary duty is a bitch, and turbo screws token holders at every turn. On leadership, Hayden has made so much dough that he has become a virtue-signaling ladder puller.

Aave is a perfect example of a protocol where it makes sense to flip a fee switch and distribute revenue to token holders. Uniswap is way more complicated. The following facts are presented to help you engage the brain for this section and draw whatever conclusion you may.

1. The bulk of LPs (Liquidity Providers) lose money.
2. Uniswap does not offer a single product. Each liquidity pool should be conceptualized as an individual offering.
3. A fee switch would have to be targeted to make any sense (only running it on a selection of profitable pools) to avoid further pain to LPers.

For those interested in toxic flow and LP profitability, find a detailed runthrough in the research piece put together by Bancor and Topaz Blue or for real nerds dive into Crocswap's series.

At a high level, providing liquidity and being profitable is a bloody tall order and if you ain’t sophisticated, you are losing money. The people making money are providing liquidity in very short bursts.  

An ongoing temperature check (how many times will they put the UNI bagholders through this pain) seeks to flip the fee switch to get all those lazy voters participating (less than 10% of circulating UNI is used in voting). In short, delegate and stake and receive shekels.

Uniswap prints and still executes the bulk of on-chain trading. But Pango just doesn’t like it.

Basically fully circulated with annual inflation of 2%, and 40% of the total supply sat in the treasury used to fund whatever squibs its way through the grants process.

Forgive me Lord for the napkin maths that is about to transpire (doubly horrific due to recent volatility spiking volume across the board). Say Uniswap hit a 25 basis point fee switch on its top five performing V3 pools and assume that the Treasury tokens are not involved.

That would be $8.32 million in fees for UNI stakers over the last week. Assume 50% of UNI gets staked (not including treasury), aka 293 million tokens. Each holder gets $0.028 per token. Annualize these figures, and each UNI token gets $1.47 in income. Not bad for a token that trades at $6, giving a yield of 23%. Note that 25 basis points would be the absolute upper limit for fees.

These figures don’t even include any of the Uniswap Labs frontend fees, which could be used to juice the returns. How much will this hurt LPs? One comment in an old governance proposal estimated that just 5 basis points would result in a 16.6% income haircut for LPs- extrapolate this and it looks painful for LPers.

This is why I don’t like the Uniswap trade. Too many moving parts and no way to tell until it is done. Will LPs exit following a fee switch? Who knows. The general assumption is that most large LPs are also large UNI holders and would recoup this lost income via revenue capture.

If you could pair trade DEX/CEX volume, it would be the most obvious long in existence. Full bull tard for DeFi over a long enough window and very bullish on Uniswap improving functionality through V4 and Hooks.

Will allow the integration of new functions into existing liquidity pools. Aka opens the door for devs (human capital) to enter the fray and start deploying cool shit, for example, options trading.  

Uniswap’s functionality is belting, but the token is meh at best.

The final take is that MC looks bloated, the token/equity split drives a horrible wedge between associated parties, and nobody knows if the fee switch will move the needle. There are just way better opportunities out there.

In investing - if it’s not a “hell yes,” then it’s a “no.”

MakerDAO: Compressing yields

Business Model: Lending, Liquidations, RWA Stimmies

MakerDAO is DeFi’s central bank and objectively positioned excellently to sweep a large chunk of the pie as more systems move on-chain.

The key point you need to understand about Maker is that it is some of the most effective connective tissue between our world and traditional finance and has positioned itself right in the bleeding heart of the entire DeFi ecosystem.  

DAI’s total supply and MakerDAO’s fate are one and the same. What did Maker do very effectively? It jumped onto the RWA bandwagon early and hit it hard. Stimmy cheques from Uncle Sam have been hitting different for MKR holders.

In February 2022, a proposal was floated to activate a RWA vault to invest in high-quality bonds. And the rest is history. MakerDAO sidestepped investing in medium-term corporate and government bonds and went absolutely ape shit bidding short US treasury bonds.

Which retrospectively was an A* gambit. Shout out Maker for bringing Uncle Sam’s stimmies on-chain via the DAI Savings Rate (DSR). As crypto picks up again, the wild dominance of RWA collateral is fading.

Pango’s short form MKR thesis

Betting on Rune’s vision and the continued expansion of DAI supply plus novel product integrations for one of DeFi’s core stablecoins. Think of the cash flows bro. Payments coming in from every angle:

• outstanding loans from borrowers
• liquidation penalties
• RWA stimmies
• excess DAI auctions
• the absolutely unbridled testosterone-fueled gem that is Endgame

Maker is unique in that it has been directing revenue towards holders for donkeys. Observe the stats for yourself at Maker Burn. Those buybacks in the illiquid books of the bear market kept MKR holders happy and in the green.

At the time of writing, Maker’s annual profit estimate is $68 million, and annualized fee income is $251 million. It trades with a P/E of 27.09. For reference, the average P/E ratio in the S&P 500 is 27.92. Certified banger.

Maker is DeFi’s central bank. The thesis can be boiled down to if you are net bullish on DeFi’s continued expansion and markets having an appetite for leverage, bid MKR.

The Tokenization Grand Prix will onboard $1 billion in tokenized assets and has attracted big fish like Blackrock and Ondo. You want leverage in DeFi? Maker has you covered for a tidy rate of 8%, and this is as cheap as credit gets in DeFi.

In crypto, you bet on founders. Rune is hot shit and a good horse to back. Endgame will transform Maker into a bunch of modular ecosystem protocols that will be self-sustaining and slash core operational costs.

Each SubDAO will create new revenue sources and plug in as a tributary to the broader network, propping up MKR’s price. The whole thing is getting faster and leaner and is on the cusp of becoming a DeFi ‘super-app’ for lack of a better term.

How do you farm these SubDAO tokens? You lock up MKR in the Sagittarius Engine which burns 15% of deposits at withdrawal. Smells hella deflationary baby.

The entire Endgame plan implements incentives driving value accumulation for MKR. While compressing yields will be a hurdle to overcome, Maker is better positioned than 99% of altcoins to thrive. Bullish on boring business models.

It is genuinely rare to see a protocol that aligns functionality and revenue with value capture for token holders so well. To have it stated: the current outflow from revenue to holders comes from the DAI Savings Rate currently paying out 7% on $2 billion in deposits.

The other central value capture for MKR holders is the Smart Burn Engine, which kicks in when the DAI surplus breaches 55 million (these parameters are constantly getting tweaked).

Literally yeets profits into MKR on the open market and pairs it with DAI to deepen liquidity. Classic stock buyback.  

The only concern is how flat DAI’s supply has been and what happens when the DAI Savings Rate takes a haircut.

How badly will this affect DAI demand? Remember DAI supply and MakerDAO’s fate are the same thing. Bigger DAI supply equates to greater bull bias.

Maker does have control over where they funnel liquidity and can augment DAI demand via the Savings Rate.

This will remain the core value distribution mechanism for the foreseeable until preference flicks back toward the Smart Burn Engine and not to forget the layered incentives for the locking of MKR Endgame introduces.

Sagittarius engine ready to shine baby. Easy long opportunity.

Compound: Why bullying works

Business Model: Interest Rate Spreads and Liquidation Fees

Compound is another OG DeFi protocol. It is a relatively boring backend liquidity tool widely used by big players and DeFi protocols.

It has over $700 million in outstanding loans backed by over $1.8 billion of collateral and uses a business model that has existed for thousands of years. Interest rate spread.

Compound makes the bulk of its fees from the difference in interest paid by borrowers and that earned by suppliers of the base asset. That’s it.

Sprinkle in liquidation fees and you have a bird’s eye view of the entire business model. But the exciting part all comes from a DAO governance raider named Humpy, who has strongarmed Compound into revenue share.

Read this governance post:

Fucking lol bro. All we need to know is that Humpy (guy who attacked Balancer back in the day) loves to crack governance. Pretty fun to read about if you have the time.

Humpy has presented a masterclass in exposing the flaws of voter apathy and dead governance while flicking the magic fee switch.

The COMP token is still steadily being drip-fed into the ecosystem, rewarding lenders and borrowers. Fun piece of trivia: Compound fired the starting pistol on the entire yield farming craze.

30% of current market reserves and 30% of new net market reserves will be streamed to COMP holders. Napkin maths says that the yield will be absolute peanuts.

Post DAO corporate raid, COMP is now a cash-flowing asset. But a cash-flowing asset for ants bruv. Absolutely scenes of unchecked poverty.  

Bear case

The overarching bear cases are relatively simple.

First, Kamala wins the White House and unleashes a reign of regulatory fire down upon crypto - unlikely but possible. Second. Somebody discovers a zero-day exploit in one of the core primitives and everything goes to zero. More unlikely still.

‍Aave doesn’t have a specific bear case outside of new smart contract risk and a large burn (operational costs).

Uniswap’s biggest bear case is unforeseen consequences to LP profitability from fee switch and liquidity migration as a result as well as the equity split prioritizing investors over token holders.

Maker’s big bear case is growing competition because now everyone has seen Tether’s attestation, they want to run a stablecoin. Flat DAI supply and crunch for DAI Savings rate when tardfi payments start to dwindle due to compressing yields.

Compound’s biggest bear case is simply being forgotten, and can see a foreseeable future where Aave eats its lunch.

Devils advocate

Bullish on Ethereum DeFi? Why not bid Solana DeFi, which trades many multiples lower and is where all the movement is this cycle.

Despite the absolute oversaturation of memecoins, the Solana DeFi landscape remains relatively sparse, given the nuclear-level extinction event that was the post-FTX period. Only the absolute die-hards and junkies remained building. Plenty of opportunity there.

Look at the numbers. Kamino trades 30X lower than Aave and has no token unlocks until April next year. Banger.

From governance to income-producing

Now that the DeFi old guard is getting a makeover and transitioning from speculative governance fugazi to genuine income-producing asset the numbers get way more important.

You, my dear friend, will have to consider things like revenue, runway, and burn rate. But the good news is that markets have overwhelming chops for things that produce income.

‍Tier List

‍Aave: A

Uniswap: F  

Maker: B-

Compound: D

True defensibility metrics in DeFi will forever be liquidity and integration. Always consider these and second-order effects before ripping into any of these tokens.

But it's very hard not to be bullish, especially in Aave’s case. We are climbing the hill of ownership, and while tokens solved the cold start problem, they will now allow you to have a genuine stake in the revenue of your favorite protocols. Do not fade income-producing assets.  

A16z released a thought piece on how application tokens can compliantly generate cash flows. Reading between the lines, this is happening now, and A16z wants cash flows to exit its early-stage investments (they hold Compound, Uniswap, and MakerDAO) and will push where needed to get this done.

A subtle takeaway is that first-mover advantages are steadily eroding, and the greatest compounding factor now is the founder's vision and direction. Bet big on founders and fundamentals.

Remember, everything is only a narrative to sell to the next marginal buyer. Good luck.

DISCLOSURES: PangolinK, the author of this report, holds AAVE and KMNO. 563, who assisted in this report, holds AAVE. Please be aware of these biases while reviewing the report.