Applying Efficient Market Hypothesis in Crypto Market through Ending of Uniswap Mining Rewards| BlockArk View
Author: Warren Fang, the Co-founder of BlockArk.
Efficient Market Hypothesis
Colleges students major in Finance will learn about the Efficient Market Hypothesis Theory soon after professional courses. The theory believes that in a transparent and fully competitive market, all valuable information has been reflected in the price, including expectations of future value.
The efficient market hypothesis is controversial in traditional financial markets because investors believe the stock is manipulated and market makers can always win. Relatively, in a transparent market, the more effective the price, the more it can reflect market expectations.
We often believe that the top-ranked cryptocurrencies have a wider consensus, more scattered holdings, wider dissemination, and more effective prices. It should be noted that although most of the information is opened, few people know it before media reports, and there is space for arbitrage.
In the second half of 2019, the market began to speculate on Bitcoin mining halving, which reached a peak in early 2020. People attributed all the rising factors to the upcoming halving. What we need to know is that the BTC/BCH/BSV halving is a fact, however, the daily halving of output will not bring about a 200% increase in demand/decrease in supply for the price actually. From the perspective of overall market cap, the impact is minimal, so it is impossible that halving increases BSV price by 200% directly. Which means, price rising was caused by FOMO.
From another dimension, we think that at the end of 2019, most investors did not realize BCH halving (at that time most only paid attention to BTC halving). After hype in early 2020, the market began to realize this incident, the expectation of a four-year supply reduction after the halving was reflected to the price.
What we need to discuss is how to obtain external profits from opened information in a relatively efficient market.
Impact of Uniswap suspension
At 8 am(UTC+8) on Nov 17, 2020, Uniswap’s first phase of liquidity mining rewards ended. UNI’s daily output was reduced from 747,944 to 473,972, a 30% reduction. The daily release amount is only the part of the team and early investors left.
From the perspective of the liquidity pool, Uniswap’s liquidity pool was withdrawn nearly half within two days. From the change in ETH’s liquidity, we can conclude that liquidity mining has played a huge role in Uniswap’s liquidity pool. TVL is not the only factor that determines the value of a DeFi project while all factors will eventually be concentrated in the currency price.
What we need to care more about is:
1. Will the decreasing liquidity cause the collapse of the UNI system and isn’t enough to support normal trading needs which prove AMM, DEX a false proposition?
2. Will the reduced UNI output reproduce the long bullish brought by the BTC halving?
From the perspective of transaction volume, we can quickly get the answer to the first question: the withdrawal of the ETH liquidity pool did not have much impact on Uniswap’s transaction volume. Uniswap’s liquidity pool can still meet the daily average of $300 million which has far exceeded the trading volume of most second-tier exchanges.
There are many factors that need to be considered to verify the second question, but we can find some clues through the price performance of UNI and the media reports. On Nov 5, the price of UNI fell to the bottom and then began to increase in volume following the rise of the market. Until Nov 10, the rise started to slow down. On Nov 11, the media began to announce Uniswap’s upcoming conference call to discuss governance issues. People began to realize that UNI’s liquidity mining would end in a week and the output would be reduced, so the second wave of escalation began until the ending of mining rewards. At that point, the profit is closed and the top appears.
Let's review the short-term UNI price performance of Uniswap’s mining rewards ending. There are three standard stages: early investors keep buying, and retailed investors purchase after media reports, and the top appears. According to the efficient market hypothesis, we conclude that the currency price caused by the ending of liquidity mining rewards in the short term has been reflected, and the market impact that may occur in the foreseeable future period of time does not need to consider UNI reduction. If other events occur in the market outlook, such as the second rise of DeFi, it is necessary to reassess the impact of other factors on currency prices.
Reasonable Valuation and Value Expectations
For the first time, liquidity mining has made digital currency holders realize that assets have an opportunity cost. In the POW era, this consciousness has not yet risen. Investors with huge capital generally put their assets in their wallets without any gains. This mentality has changed after two phenomenal industry events : IEO in 2019 and DeFi liquidity mining in 2020. After gradually transitioning to the POS era, investors began to expect the annualized return of holding assets.
In the crypto industry, the expected return will vary according to the risk of the platform. In relatively frontier fields, such as DeFi’s liquidity mining, investors generally accept a lossless annualized return between 20% and 30%, while in a relatively conservative centralized wealth management platform, this return can be reduced to less than 10%. Uniswap’s liquidity mining and Binance’s Launchpool are two indicators we can refer to.
The income of liquid mining is not all the income pledged to the Uniswap liquidity pool. For investors, another piece of income comes from the share of handling fees. We calculate based on an average daily transaction volume of $300 million and a handling fee of 0.3%. The daily fee share is also close to $1 million, which is equivalent to the mining output of UNI.
One thing that needs to be drawn here is the expected dividends of governance tokens. The bubble of liquid mining started with COMP, detonated the market through YFI, and reached its peak when the SUSHI and UNI launched. However, the most popular project tokens in the market are governance tokens, and there is no substantial revenue share. We believe that the rising logic of governance tokens largely comes from people’s expectations of dividends from project tokens. This is why on decentralized platforms and DeFi projects, TVL and total transaction volume/lending volume are positively correlated with the project’s token market value scale. People believe that holding governance tokens will be possible in the future to obtain the platform’s fee sharing. According to the efficient market hypothesis, such expectations are discounted to the current price.
Take UNI as an example. According to the unit price of $3, the current market value is about $600 million, and the fee income alone is
more than $300 million, only less than twice the PE, and there is huge room for growth. This is the basic logic that many people still hold UNI and are optimistic about the long-term.
Therefore, for a DeFi project for liquid mining, mining output and income expectations are two important factors that determine the currency price. Mining output determines supply, and income expectations determine demand. We have sorted out the daily release volume of the top DeFi project and the recent major events that have affected the supply volume. Combined with the market value and trading activity of the project itself, we can better estimate the token. We found that the top DeFi projects, such as SNX and YFI, have a daily output that can be ignored relative to the overall market value of circulation. When considering estimated market cap, only the fundamentals of the project can be considered. On the other hand, it is not wise to buy UNI in the secondary market at the beginning of its listing, because the daily release will produce huge selling pressure, and after the liquidity mining is over, the benefits will be realized and the profit will be fleeing. There will be an opportunity to buy at the bottom.
New price model
Unlike most mining projects, where prices are determined by supply and demand in the secondary market, some DeFi projects innovatively use a new price model. For example, the insurance project NXM, its token price is determined by the amount of funds participating in the insurance fund pool, which means that wNXM traded in the secondary market often only provides an interface for external speculation, and arbitrageurs will balance the two sides through arbitrage. If the insurance demand is strong (such as the recent lightning loan supply incidents, the insurance sector prices soaring), it will indirectly drive the increase of the insurance fund pool from the outside, and further, promote the development of the project.
Many people will be curious why this wave is the rise of DeFi? Why is it rising at this time? Is DeFi a bubble? We always believe that after many years of development, the crypto industry has finally reached the time for the rise of value. Compared with 2017, the rise of DeFi is essentially true recognition of decentralized products, because the improvement of decentralized lending/exchanges truly solves people’s needs. We can see that after experiencing many plagiarisms and forks and the ending of liquidity mining, Uniswap still maintains an average daily real trading volume of $300 million, which means the true value of decentralization.
The tokens reflect people’s expectations of future value. In DeFi, a relatively effective market (the transaction volume, the number of users are relatively more real, and the community decision-making brought by DAO governance), people tend to pay more attention to products’ real utility. With the real utility of the coming, the market has become more eager for projects that have created a new financial model. We look forward to more unicorns, and we look forward to the value of the crypto world and decentralization being recognized by more people, and all of this will be reflected in the price.
The question is, on the day when the mainstream market recognizes the crypto world, on the day when this rarely known information is known to most people in the world, are you one of the holders?