Become a full Formal Verification member and receive complete research and member-only bonus content. Get full access for $10/month or $100/year.
Kyber
Kyber is an on-chain liquidity protocol on Ethereum that allows dApps, wallets, and end users access to competitive exchange rates for cryptoassets through a liquidity reserve model. Any token holder can contribute liquidity as an external reserve but these reserves are required to hold KNC in order to contribute resources to the network. For most trades that occurs on the network, a protocol fee of 0.25% is paid by the reserves - 30% of this fee is rewarded to dApps bringing volume to the network (Fee Sharing Program) and 70% is burned (0.175% of fee).
The Transition to Katalyst
In December, the Kyber team announced the Katalyst upgrade that aims to optimise the KNC token design as well as remove unwanted friction for network participants wanting to contribute to the network.
For those unfamiliar with Katalyst, it will introduce staking which will allow KNC holders to directly receive part of the network fees (in ETH) paid by reserves. Additionally, the formation of the new KyberDAO (that will be maintained by the Kyber team) will give KNC holders governing rights over the network and will be able to determine how fees are split between burning, staking/voting, and reserve incentives. Other notable changes include the complete removal of the upfront KNC requirement for reserve managers as well as the fee sharing program.
The key thing here is that, while the token design overall has changed with Katalyst, the total available rewards from network fees (i.e. value flows) is still proportional to the volume traded on the network regardless of how these fees end up being split.
With the above in mind we will analyse Kyber in 3 respects:
Key network highlights heading into Katalyst
KNC value composite metrics
KNC as a market-neutral asset
Key Network Highlights
In the conventional model, KNC proportional to the network trade volume is burned. In Katalyst, stakers will have the option to receive ETH fees proportionate the network volume directly. Therefore, volume is still one of the absolute core metric for KNC holders to keep track of going into Katalyst.
Kyber volume grew to average $3 million daily during the ETH bull market mid 2019 showing higher monthly trade volume each month until around August. However, with continued liquidity contributions, dApp integrations, and continued interest from end users, average daily Kyber volume increased and the network recorded its highest daily (~$37m) and monthly volume (~$200m) in March 2020, largely driven by the March 12th events.
Average trade size is also an important metric for exchanges. Since the start of 2019, we can see that the average trade size has been climbing while spiking during times of intense bullish and bearish market conditions. Average trade size has grown from ~$430 at the start of 2019 to ~$1100 seen today. This trend might be indicative of users becoming more comfortable trading larger amounts per trade and/or by Kyber dApp integrations themselves (more on this later).
Overall, we can see that the KNC market price has largely trended in line with exchange fees taken by the protocol. In theory this is what we would expect with effective incentive design for decentralised networks - higher volume on the protocol leads to proportional amount of fees taken which as then subsequently burned, increasing the scarcity value of KNC. With Katalyst, the nature of value flows have somewhat changed - value created from trading volume feeds directly to KNC stakers who decide how network fees are ultimately processed.
However, not all trading volume contributes to fee collection. One of the most overlooked aspects of Kyber is the removal of fees from Bridge Reserves implemented in late 2019. As a quick refresher, Kyber has 3 types of reserves that contribute liquidity - Price Feed Reserves (PFRs), Automated Price Reserves (APRs), and Bridge Reserves (DEXs). For each trade, all reserves are scanned and chosen for best price.
Bridge Reserves are designed to bring liquidity from other on-chain providers (e.g. Uniswap, Oasis, or Bancor). The removal of Bridge Reserve fees was to allow the best price quotes for end users as well as dApps tapping into Kyber. While this move might help give Kyber a competitive edge within its niche, it naturally leads to a slight reduction in KNC fees burned than would have if these these fees were maintained.
To understand why this is important, Bridge Reserves have accounted for ~30% of the USD denominated trading volume since the start of the year with the majority of the liquidity being pulled from the Uniswap Bridge. Put differently, fees have not applied to ~$185m Bridge Reserve trading volume from January to May 2020.
Overall, the removal of these Bridge Reserve fees is somewhat of a necessary evil as dApps are more likely to integrate to Kyber as a single endpoint for liquidity strengthening Kyber’s position in the DEX market. It is worth keeping a close eye on any trends here as this can affect the available fee rewards for KNC stakers in Katalyst all else being equal.
Valuation Composite Metrics
For cryptocapital assets, analysts often use comparable company analysis (CAA) such as P/E for single time snapshot cryptoasset comparisons or discounted cash flows (DCFs) to derive on a PV based on estimated future cash flow growth liking value flow in networks to value flows within a company (see here for Hash’s recent Kyber example).
The difficulty here is that value flows on a per unit basis can change dramatically over time. For CAA models, earnings might be underestimated if only 2% of the supply is opting in to receive a large pool of rewards. For DCF models that calculate unit value, there are strong assumptions with both the future growth rate of nascent decentralised networks as well as the stake ratio - how many tokens will be receiving value flows multiple years (often 5 years) into the future? In reality, staking is a continuous process as token holders constantly evaluate whether to opt in/out of receiving these value flows.
About Formal Verification
Institutional-grade digital asset research
Formal Verification offers both key and concise data analysis and ecosystem research for decentralised networks and digital assets so you can be attuned to the absolute key developments both on and off the chain.
Become a full Formal Verification member and receive complete research and member-only bonus content. Get full access for $10/month or $100/year.
Formal Verification research is not investment advice and is strictly for informational purposes only. Please conduct your own research.