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Blockchain and cryptocurrencies have evolved in use over the last decade ago. Gone are the days when Bitcoin was the only known cryptocurrency. Countless blockchain projects have been created over the years. As new ecosystems are built out, it can be difficult to create a strategy to capture Alpha throughout the development of each ecosystem.
Not too long ago, MoneyWithCarter examined the growth of new chains and the processes they follow.
MoneyWithCarter sought to explain how such an ecosystem legitimizes itself. From the analysis, this is what happens:
- Shitcoins bring in short-term speculators.
- The Community will then find favorite projects that are native to that layer.
- A native aggregator pumps, allowing the value to move efficiently.
At Momentum 6, we have analyzed the growth of new chains to determine where we can capture Alpha. After further analysis, we determined that the MoneyWithCarter analysis is a great description of the money flow for new chains, as we have similar conclusions. We expect this same theory to pan out in most emerging Layer 1 ecosystems.
Basic building blocks are needed to enable the growth of an ecosystem. To start, a decentralized exchange (DEX) must be there for basic market buys and sells. The native DEXs are usually the initial ‘yield farm.’ These DEXs, most of the time, outperform omnichain “blue chips’ like Sushiswap.
Farms and Shitcoins
Yield farming is the process of lending cryptocurrencies in the hope of getting interest or sometimes a share of the network fees. Yield Farms are essentially the places where crypto owners lend their coins. This is what usually happens with yield farms:
- Akin to the first DEXs, users will usually chase high yields based on their liquidity.
- Most of these farms are fundamentally weak, only dispensing an arbitrary farming token.
- We also noted that most of these farms have high annual percentage rates (APRs) for liquidity providers. This approach is vital as it attracts users to buy and stake the token.
- Most of these yield farms follow “Ponzinomics”.
Shitcoins are primarily coins that are created as memes or copycats. These coins diminish in value over time as they are mostly created and priced based on speculation. Such digital currencies are thus considered to be bad investments. This is what happens with shitcoins:
- Users will chase high return on investment from shitcoins with a low market cap.
- Most of these coins die off as they are fundamentally weak.
- A small group of these coins redefine themselves and continue to build their product to become a strong project. A good example of this is SushiSwap.
Native protocols on new chains have a stronger chance of earning a large market share on that particular chain over the omnichain blue chips, such as Sushi, Aave, and Beefy.
Only the strongest tokens, which often form strong communities, will start to outperform and capture large amounts of Total Value Locked (TVL) for that sector. These coins will not have the highest Annual Percentage Yields (APYs), but they will be seen as safer, and resulting in a higher TVL. However, these coins typically have insufficient liquidity, leading to the presence of many arbitrage opportunities amongst the pools of liquidity.
Returns on various farms can vary significantly. Hunting down yields on multiple platforms can be very tedious. Yield aggregators are protocols that automate this process and help users get the highest rates by moving funds between various DeFi platforms in search of the highest yields.
Yield aggregators are needed to move liquidity more efficiently. Users put liquidity into aggregators, the aggregator moves the liquidity to the most lucrative pools. These aggregators inherently minimize most of the arbitrage opportunities amongst pools. Aggregators cause TVLs to grow as it makes yield farming easier to manage. Although yield aggregators come in last, as they need other protocols to run, they are an integral protocol for DeFi to run smoothly.
Real-World Example: Arbitrum
Arbitrum is a perfect example, as it had a TVL rally last summer as a high yield farm grew the TVL of this new chain to $1.5 billion. However, the farm collapsed.
Yield Farms use liquidity providers (LPs) to provide liquidity to decentralized exchanges, making them crucial for swaps. As new buyers chased the high APY of ETH-Nyan, they drove the token price to the moon. When the token price dropped below a certain threshold, APY’s became less attractive and buying volume dipped. Sellers drove the price of the token down, leaving LPs with only arbitrary tokens.
Arbitrum now appears to be in limbo between the shitcoin stage and new emerging blue chips on the chain. There are only a handful of good protocols building on Layer 2 (fyi, Arbitrum is a Layer 2). There are a few fundamentally strong projects, such as $GMX and $CAP, but these projects still need to be battle-tested before challenging bigger perpetual protocols.
Wrapping up — What to expect going forward
- Expect to see us getting early involvement in native DEXs with new chains. DEXs are the key building blocks for DeFi and are also easy to farm by being a liquidity provider.
- Expect to see several lending, perpetual and synthetic protocols that are strong and will outperform the rest. Such protocols will have a better chance of stealing a significant market share from blue chips based on the better ROI or better farming APYs.
- Lastly, we want to get involved early with native yield aggregators as we understand that it is the last piece of a DeFi ecosystem to run efficiently.
These protocols are the building blocks for an ecosystem. We anticipate these protocols will be involved in almost every chain, from DeFi to gaming, on some level. This was a basic ecosystem money flow overview, there are vanity protocols that arise after, such as launchpads, which are not essential to us at the moment.