Wyatt: Crypto lending markets are sustainable despite recent declines, the critical role of Total Value Locked (TVL), and the risks of leveraged systems

Key takeaways

• The crypto industry experienced a cyclical high in September and early October, followed by a significant decline.
• Total Value Locked (TVL) is a critical metric for valuing DeFi protocols, often discussed in the context of lending markets.
• Lending markets in crypto are sustainable due to their unique value proposition, which cannot be replicated outside of crypto.
• The decline in total value locked in lending markets highlights current challenges in the crypto space.
• The failure of platforms like Celsius and BlockFi has created opportunities for DeFi lending platforms.
• Understanding risks in on-chain lending platforms requires a high level of expertise, posing a barrier for users.
• The integration of Morpho with Coinbase has significantly increased collateral for borrowing against Bitcoin.
• The concept of looping in lending markets allows for recycling capital, increasing potential yields.
• Lack of traceability in leveraged systems poses significant risks in the crypto lending market.
• Cross depositing vaults is a dangerous strategy due to the concentration of risk.
• The availability of stablecoins is crucial for lending in crypto, influencing platform dynamics.
• Many crypto platforms do not generate revenue justifying their token valuations, reflecting market challenges.

Guest intro

Wyatt Khosrowshahi is an Investor at Castle Island Ventures. Prior to joining in July 2023, he served as an Investment Analyst at Shima Capital, focusing on companies leveraging blockchain to improve web2 industries. He recently co-authored the “Total Value Lost” report assessing the value of DeFi markets, starting with lending protocols.

The rise and fall of crypto valuations

• “The September and early October period marked a cyclical high in the crypto industry, followed by a significant decline in valuations.” – Wyatt
• Understanding the timeline of crypto market fluctuations is crucial for assessing current valuations.
• “In retrospect, the September and early October period marked a cyclical high in the industry.” – Wyatt
• The October 10 crash significantly impacted DeFi metrics and crypto token valuations.
• Total Value Locked (TVL) is a key metric for evaluating the success of DeFi applications.
• “People talk about TVL a lot, which is a capital-raising tool for DeFi protocols.” – Wyatt
• The decline in TVL reflects broader challenges in the DeFi space.
• Understanding TVL is essential for assessing the value of DeFi protocols.

Sustainability of lending markets

• “Lending markets in crypto are sustainable due to their unique value proposition.” – Wyatt
• The demand for turning nonproductive assets into productive ones drives the durability of lending businesses.
• “The current state of the lending markets shows a significant decline in total value locked.” – Wyatt
• The decline in TVL highlights challenges in maintaining sustainable lending markets.
• “The conversation about what metrics matter in emerging business types is reminiscent of early internet discussions.” – Wyatt
• Understanding the evolution of metrics in tech startups provides context for current crypto discussions.
• The failure of centralized platforms like Celsius and BlockFi has benefited DeFi lending platforms.
• “DeFi platforms like Aave and Morpho have benefited from the void left by Celsius and BlockFi.” – Wyatt

Risks and challenges in lending strategies

• “Understanding the risks associated with on-chain lending platforms requires a high level of expertise.” – Wyatt
• The complexity of DeFi lending markets poses a barrier for users.
• “The integration of Morpho with Coinbase has led to significant growth in collateral for borrowing against Bitcoin.” – Wyatt
• The concept of looping allows for recycling capital, increasing potential yields.
• “Although crypto is extremely traceable, it’s virtually impossible to identify how levered a system is.” – Wyatt
• Lack of traceability in leveraged systems poses significant risks.
• “The strategy of cross depositing vaults is extremely dangerous due to the concentration of risk.” – Wyatt
• Understanding vault strategies is crucial for assessing risk in lending markets.

Valuation and market dynamics

• “Many crypto assets may not be worth their claimed market cap due to low trading volumes.” – Wyatt
• The lack of a fundamental floor for many crypto assets creates significant uncertainty.
• “Funds can inflate their net asset value (NAV) to charge higher fees, creating a conflict of interest.” – Wyatt
• Choosing fund managers who prioritize performance fees can mitigate the risk of inflated asset valuations.
• “The high watermark mechanism prevents fund managers from earning performance fees until they exceed previous peak valuations.” – Wyatt
• Market valuations in crypto are often based on incorrect metrics, leading to mispricing.
• “The valuation of lending protocols should focus on revenue-generating activities rather than TVL.” – Wyatt

Evolution of the crypto industry

• “The crypto industry is undergoing a discovery phase similar to traditional finance.” – Wyatt
• There is a consensus emerging on sector mapping within the crypto industry.
• “The availability of stablecoins is the most critical metric for lending in crypto.” – Wyatt
• Most crypto platforms do not generate revenue that justifies their token valuations.
• “Very few startups in crypto are profitable at the time of investment.” – Wyatt
• Investors are asking for revenue to ensure trust and validate the teams behind crypto projects.
• “Current valuations in crypto are often inflated based on future revenue expectations rather than actual revenue.” – Wyatt

Talent and investment in the crypto space

• “Venture capitalists are paying high premiums for talent in the crypto space due to its scarcity.” – Wyatt
• The lending markets in crypto may be underpriced, requiring a long-term investment perspective.
• “Investors may be overpaying for crypto assets now or in the future, depending on their investment horizon.” – Wyatt
• The current valuations of DeFi protocols are not reflective of their total addressable market if they succeed.
• “The leap from early-stage protocols to monetization is a significant challenge for many teams.” – Wyatt
• Valuations in the crypto market are heavily influenced by the supply of capital rather than intrinsic value.

Macro factors affecting crypto

• “Crypto is highly sensitive to interest rates and operates as a macro trade.” – Wyatt
• The current bear market in crypto is paradoxical, with high valuations but extremely negative sentiment.
• “The tightening of monetary policy could lead to a more favorable environment for crypto in the future.” – Wyatt
• Lending markets can thrive in both high and low interest rate environments due to borrowing costs and market volume dynamics.
• “As interest rates decrease, we can expect an uptick in borrowing volume and a recovery in the lending market.” – Wyatt

By organizing these insights into thematic sections and key takeaways, we provide a comprehensive overview of the podcast episode, capturing the essence of the discussion and the expertise shared by Wyatt.