As regulators and industry participants across the globe continue to hash out details of the forthcoming digital asset legislation, stakeholders in favour of enhanced disclosure may rejoice at the transparency and availability of protocol-level data. Freely accessible disclosure helps reinforce market integrity. The nature of public blockchains means that transactional information is available in almost real-time. Querying and indexing the data can be tricky, but there are many services and intrepid analysts who provide free synopses for those who have not developed the skills themselves. As with accounting, there are differences in calculation methodologies, but it’s still helpful to see economic and commercial trends unfold with a greater frequency than periodic regulatory filings.
I’ve had an affinity for the bank business model since first getting into finance. To me, it’s cool how an intermediary can build a profitable business by combining security with the supply and demand of capital. In fact, it’s the codification of lending markets that truly sent me down the rabbit hole of decentralized finance. I haven’t been back up since… Therefore, I was keen to flip through Maker’s 2022 annual report – especially in the context of recent regulatory emphasis on disclosure.
MakerDAO is one of the original DeFi projects. It was conceptualized in 2014 with the objective of creating a permissionless lending platform, where users could mint DAI (a stablecoin with a soft peg to the U.S. dollar) by depositing collateral into a smart contract. DAI can be used within the digital asset ecosystem and its peg is maintained through a combination of overcollateralization, automated transaction mechanisms, and game theory (you can learn more here). Initially, the “vaults” underpinning the asset were secured with Ether, but other tokens are now accepted as well. In 2021, Maker began to issue DAI backed by off-chain loans; a vertical now called real-world assets (RWA). From a balance sheet perspective, DAI represents the liabilities of the protocol, which are secured by client deposits in a smart contract. This is like a bank-issued term deposit, which promises to repay the holder, plus a rate of interest (liability) in exchange for cash (asset).
As you’d expect, it was a tough year for Maker financially. Relative to 2021, Revenues declined 42% to 65M* and Operating Expenses increased 119% to 46M. Overall, the protocol incurred a significant profitability hit, as Net Operating Earnings collapsed 79% to 18.8M. The top line weakness can be attributed to an overall deleveraging of the digital asset market while rising costs relate to organizational restructuring (which most public companies would adjust out of their reported profitability figures). Some bad debts were incurred, but inconsequential relative to the size of the balance sheet. Impressively, the protocol still made money during the worst credit crisis experienced on-chain.
*Maker denominates their financials in DAI
Maker is a pioneer providing this level of granularity in their annual report, which they acknowledge involves some subjectivity. That said, we can use data available on-chain to compare some metrics across peers. Two of Maker’s main competitors in the crypto economy are Aave and Compound. The charts below are far from exhaustive, but they provide a good starting point for evaluating each protocol’s relative standing.
In traditional finance, using a Price-to-Sales (P/S) ratio is problematic as a valuation metric because investors only have a claim on the residual cash flows of a business and there are several lines between revenue and profit. However, the figure does provide a quick assessment of how much investors are paying for a dollar of sales. Here are the [Fully Diluted Market Cap / (Avg. Annualized Trailing 28-day Sales)] for the major DeFi lenders:
In this regard, we can see that Maker tends to trade expensively on a relative basis, which might have to do with their first-mover pedigree and crypto-sector-leading size. Alternatively, investors may place a high degree of probability that the protocol can “optimize its balance sheet further” as mentioned in the report. Compared to traditional equities, all three would be characterized as strikingly rich.
Total Value Locked (TVL) is the amount of capital committed to a DeFi protocol. This metric is challenged in the sense that when it’s measured in USD, the value of the collateral will fluctuate with the market. However, comparing across on-chain lenders makes this less relevant. As with the P/S ratio, investors will often standardize metrics for relative valuation by using price as a numerator. In the case below we present [Fully Diluted Market Cap / TVL]:
Market observers typically regard a [Mkt. Cap / TVL] reading below one as an indication of good value. Maker screens relatively cheap, which warrants further investigation. Are Aave and Compound pricing-in some future catalyst that’s expected to attract additional TVL? Are Maker’s assets at risk? Perhaps it’s another example where underperformers lead out of a bear market…
To get a health gauge for a technological ecosystem, it’s common to look at Developer Activity. Below we present charts showing the count of developers who are actively building within the big three lending protocols:
Total Developers (trailing 28 days):
New Developers (trailing 28 days):
The trend in new devs is most interesting as we can identify a sharp rise in first-time Maker engineers. What might be luring them in?
Finally, while it’s great to see a robust ecosystem of developers driving innovation, a rough measure of their success in building products that people want to interact with is Daily Active Users (DAU). Again, we’ll standardize this metric across the three lending markets using [Fully Diluted Market Cap / DAU]:
Here, Aave is the clear leader. I investigated using on-chain data and noticed that the rankings in the chart above match the group’s normalized [Total Revenue / DAU] rankings, implying that the market rewards positive rates of change in sales conversions.
As in traditional securities analysis, evaluating protocols using relative valuation is a mix of art and science. What I find most interesting is that this data is available block after block, permitting stakeholders to see changes in fundamentals as they play out. In addition to informing token price speculators, the information can help with counterparty risk assessment and avoids asymmetries of information which lead to plights like insider trading.
In the next Digital Dive, we’ll continue our discussion of how on-chain data can enrich our analyses, by tapping into recent disclosure from traditional financial institutions to answer the questions posed above. Importantly, we’ll unveil why it’s likely that the information pulled from public blockchains, regulatory filings, and earnings calls are likely to overlap progressively in the coming years.
