TVL has dropped to eighth place, what happened to the once-glorious Polygon?

Author: SeerLabs

Preface:

Recently, the updates have been delayed for too long. The main reason is that I have always hoped to conduct research that is not merely "universal," "information summary," or "data analysis" reports. Instead, I wish to deeply explore issues through a specific track, field, or phenomenon and propose corresponding solutions. The focus of the report often lies in the discovery of problems, the thought process, and the final solutions, rather than the project itself. Therefore, the preparation time has been longer.

Moreover, with the recent rampant rise of MEME coins and the metaverse, I have not found a topic I wanted to write about. However, recently, a project we have been following raised a question that sparked a lot of thoughts for me, so I am organizing my thoughts here.

This article will start with the existing problems of Polygon, exploring the competition of underlying protocols in public chains, the structured evolution of DeFi, and the product directions I can offer based on the existing ecosystem, ultimately deducing some solutions I hope for.

Similar to previous research reports, reading this article requires a certain foundation, but I will explain some basic principles in a concrete way using flowcharts. This article is not a wealth code, contains no investment advice, and is purely a discussion from a product manager's perspective. If there are any objections, please contact me.

"Battle is the primary productivity of product managers."

01 What will save you! My Polygon

Starting with the title, I believe that in recent times, the number of times people have heard about Polygon has become quite limited. The hottest concepts and public chain protocols in the market are emerging one after another, with Solana, Fantom, Avalanche, Terra, and Arbitrum's protocol locked value all surpassing Polygon.

Polygon's TVL has dropped from its peak of 10.54B on July 15 to the current 5.04B, a decline of more than half. Among all public chains, layer 2s, and EVM Fork chains, its ranking has fallen from the fourth to the eighth.

Through our communication with various project parties cooperating with Polygon, they generally reported a common issue—"For new projects, both the funding and user numbers on Polygon have significantly shrunk, community activity has also decreased, and traffic and retail funds have been attracted by other underlying protocols."

(1) What caused the problem?

1. Other products like Solana, Fantom, and Avalanche provide more opportunities for retail investors to go from 0 to 1.

High incentive support programs have led to the re-emergence of models that were once popular on Polygon and other underlying chains on these new public chains. "Hot money" continues to seek fresh speculation hotspots.

2. An overly aggressive cold start strategy has prevented Polygon from incubating its own star projects.

Since the launch of the DeFi for All fund in mid-year, Polygon has chosen a strategy that now seems very aggressive, introducing blue-chip projects from the original ETH ecosystem like Aave and Curve through $MATIC incentives. This had a very positive impact on both sides in the short term. However, it has also led to many problems in the long term.

According to DeFiLlama data, the top ten projects on the Solana chain are all exclusive to Solana:

Moreover, looking at the investment institutions of these projects, most have received direct investments from the Solana Foundation, Alameda Research, and even FTX.

Currently, among the top ten projects on Polygon, only Quickswap and Dinoswap are exclusive to the Polygon chain.

Among these, leading projects like Aave, Curve, Sushiswap, and Balancer all come from the DeFi for All program. Even Aave's dominance has reached an astonishing 40%. This level of market share for leading projects is only comparable to the relatively closed Terra; other competing public chains do not exhibit this situation.

From the performance in the later stages, especially the overly All-in strategy in the early stages has led to Polygon being unable to provide more help and liquidity guidance for new projects when facing competition. This has made it impossible for users to continuously discover new investment targets on Polygon in a market dominated by FOMO sentiment.

This further leads to the loss of traffic and funds.

3. Blindly chasing hotspots and constantly changing marketing focuses have led to a phase-wise neglect of developers.

After following Polygon's community official accounts and developer official accounts, one can find an interesting phenomenon. During the hot period of DeFi summer, Polygon would promote some DeFi projects' activity rankings and TVL rankings. However, as the market focus shifted to NFTs and GameFi, Polygon's main promotional direction gradually shifted to other fields.

From the perspective of general market competition, this timely strategy seems to pose no problem. However, due to the second issue mentioned above, Polygon's officials should pay more attention to long-term and stable ecological development compared to other competitors.

From the feedback we received, the severe Matthew effect of funds and the constantly changing support focus have made it difficult for project parties to maintain continuous and stable urgent communication with Polygon officials. This makes it hard to jointly create exclusive star projects.

Hotspots are constantly changing and at a rapid pace. However, some basic innovations are still in their early stages. Blindly changing hotspots, DeFi 2.0, NFT 2.0, GameFi 2.0 may not even have a place for Polygon.

(2) How to solve it

1. Reutilization of interest-bearing assets in DeFi 2.0

Before discussing solutions, we need to understand a stablecoin project—Abracadabra (Spell). For convenience, I will refer to it as Spell.

Spell has also released a version on the ETH MainNet, which has over 276 total protocols, but the top ten products account for over 80% of the TVL.

Most of these projects have been released for over two years, and in the DeFi metaverse of ETH MainNet, it is almost impossible for new over-collateralized stablecoin protocols to attract new funds for locking.

To address this issue, Spell made a bold decision in its product design to use interest-bearing assets as collateral for the protocol.

These interest-bearing assets include yvAsset and CvxAsset, among others. It even includes riskier composite interest-bearing assets like yvcrvAsset. The main logic behind this is illustrated in the diagram:

Users can deposit native tokens, USDT, ETH, etc., on platforms like yearn finance to generate interest-bearing assets and obtain yvUSDT and other interest-bearing assets. They can then use yvUSDT and other interest-bearing assets as collateral to mint Spell's stablecoin MIM. MIM can be exchanged for other stablecoin assets through Curve's MIM3POOL.

The benefit of this approach is that users' native assets can earn returns provided by platforms like yearn finance while also leveraging Spell to repeat operations and obtain more returns.

Currently, Spell supports amplifying single collateral leverage through flash loans. Essentially, this greatly improves the capital efficiency of existing funds.

Additionally, another benefit of this approach is that it is very conducive to the cold start of projects. Currently, Spell's total protocol TVL has exceeded 4 billion USD, with most of it coming from such interest-bearing assets.

From Spell, we can see that stimulating the creation and reutilization of interest-bearing assets may be a feasible way to solve Polygon's dilemma.

2. What should Polygon ecosystem projects do?

Polygon ecosystem projects should start trying to reutilize the existing assets of blue-chip leading projects. For example, the largest DeFi project on Polygon, Aave's aToken. This is a type of interest-bearing asset where users can deposit any supported assets like ETH, USDT, DAI into Aave's deposit contract, and Aave will provide the corresponding aToken, which will calculate the user's principal + interest returns. Assuming we assume no significant contract risk with Aave, we can even consider that the risk of aToken is lower than that of native assets like ETH, as the continuously increasing interest also hedges against the price volatility risk of native assets.

However, different products provide interest-bearing assets with varying calculation methods, pricing models, deposit, and withdrawal mechanisms. This makes it difficult for new project parties to reutilize these existing assets, and they may even be forced to modify contracts or achieve upward compatibility. This is fundamentally problematic.

Taking aToken as an example, the number of aTokens users receive is not 1:1 pegged (to be honest, from a composability perspective, this is a terrible approach), but continuously increases. The interest income you earn will be directly reflected in the number of aTokens calculated in currency terms.

For example: deposit 1 ETH to get 1 aETH. As interest continues to accumulate, you will find that your 1 aETH gradually becomes 1.1, 1.2, 1.3. When you decide to exit, 1.3 aETH can be exchanged for 1.3 ETH. The 0.3 ETH is the interest income during that period.

Although this is easy to understand from the user's perspective, it poses a problem when trying to reutilize assets like aToken.

For instance, when using it as collateral to borrow other assets. Generally, the amount of collateral remains unchanged, while the price is a variable. However, the number of aTokens continuously increases, which turns the amount of collateral into a variable during minting and burning.

Taking Curve as an example, the Polygon version of Curve provides an interest-bearing token, the aave 3crv token. Its form is:

As shown in the diagram, the LP tokens provided by Curve here are also a type of interest-bearing asset, but this type of interest-bearing asset includes both aToken deposit interest and LP fee income.

Moreover, the LP tokens provided by Curve are a type of token that provides pricing and remains unchanged in quantity. This type of token generally meets the various conditions to become a standard collateral.

However, the problem is that the Polygon version of Curve focuses more on large exchanges of stable assets. Therefore, the available interest-bearing assets are limited.

And the most serious problem arises: LP tokens need to be re-collateralized to obtain CRV and Matic liquidity incentives issued by Polygon. Damn it!! If a project wishes to use such LP tokens as collateral, it means that the liquidity incentives it provides must exceed those jointly provided by Curve and Polygon to attract users.

Convex supports collateralizing Curve pool LP tokens to obtain returns including LP pool income, CRV, and CVX incentives. However, again, Convex is currently only deployed on the Ethereum mainnet, and consequently, its cvxLP token cannot be effectively utilized on Polygon.

It seems to have gone in a circle back to the awkward situation of fighting over existing funds.

However, this situation does not occur on the ETH chain, as yield aggregators like Yearn Finance will repackage all the aforementioned liquidity to provide interest-bearing assets like yvAsset. They also encompass liquidity mining token incentives.

From the perspective of interest-bearing models, we can categorize interest-bearing assets into the following types:

Therefore, the solution to the problem seems to emerge: if Yearn Finance or similar products can gain greater adoption, it may enhance the activity of existing funds and further promote the development of new projects.

According to DeFiLlama data, the largest Yearn-like product on Polygon is Beefy.finance. However, its overall TVL is only 150 million, and it is still concentrated in strategy pools like Curve, Quick, and Sushi.

From the perspective of basic product design and data, Beefy may fit our vision, but its credibility is still not high enough, and its multi-chain development strategy does not align with Polygon's own interests. Therefore, relying on supporting Beefy to break the deadlock may not be the best choice.

So what kind of product is most suitable for the Polygon ecosystem? This leads to my other thought—layering ecological products based on demand.

02 Maslow's Hierarchy of Needs in the DeFi Ecosystem

As we all know, Maslow divided human needs into five levels from a psychological perspective: physiological, safety, social, esteem, and self-actualization.

The first four levels are referred to as deficiency needs, while the highest level is called growth needs. A key point is that higher-level needs must be met before lower-level needs can emerge.

Mapping the psychological needs hierarchy theory to the demand hierarchy of DeFi products, we can observe a clear phenomenon. Users' needs for DeFi products also exhibit a distinct demand hierarchy.

Let us illustrate this point with a structural diagram:

The above diagram categorizes various DeFi products based on actual demand. Following the structure, we find that when only underlying protocols exist, blockchain essentially cannot produce many variations; this stage can be seen as the Bitcoin and altcoin phase.

When ETH emerged, programmable assets appeared on-chain, enabling the creation of complex logic smart contracts. Thus, various DEXs came into being.

When on-chain liquidity is sufficient to provide stable oracle prices, or when specialized oracle pricing protocols like Chainlink appear, users can price collateral, which is when lending protocols like MakerDAO, Compound, and Aave began to emerge.

The only controversial area here is insurance. In the traditional financial system, insurance has always played a crucial infrastructural role. However, decentralized production relationships have temporarily prevented insurance from fulfilling its foundational protocol role. Nevertheless, the concept of insurance is the basis for various derivatives protocols like futures and options, so I still place it in the first-level demand category.

Thus, from the perspective of combinatorial innovation, we can also represent it in a tree-like form.

Following this logical flow, we can easily see that the development of the DeFi ecosystem also strictly evolves according to the demand hierarchy theory. Moreover, the emergence of higher-level needs is fundamentally based on the satisfaction of lower-level needs.

In the Polygon ecosystem, first-level needs have received sufficient liquidity support, and second-level needs have been basically met. However, due to the overly aggressive incentive strategies mentioned earlier, the addition of new second-level needs has been limited, resulting in overall poor vitality. Therefore, fully leveraging third-level needs by establishing and supporting quality asset management to create a more stable and sound interest-bearing asset ecosystem may stimulate innovation in fourth-level derivative protocols, generating new hotspots while also benefiting other ecosystems like NFTs and GameFi.

So what do I understand as the best product solution?

03 Ideal Asset Management Tools

(1) Standardized integration of first and second-level demand functions

In any ecosystem, the foundational first and second-level needs are prerequisites for ecological explosion, as they provide the basis for liquidity and protocol combinations.

However, in practical operations, users will encounter difficulties in information retrieval, separate authorizations, and certain learning thresholds.

Therefore, better asset management tools should first be able to standardize the integration of first and second-level demand protocols. In this regard, Instadapp serves as a good example.

Instadapp provides standardized functional integration of multiple foundational protocols and offers a unified account management system and rich developer support.

This greatly reduces the various operations and learning costs incurred when users transition between different demands and provides many targeted functions for changes in different protocols, such as the debt transfer function between Maker and Compound, and debt updates between Sai and Dai.

However, this is still not perfect. Instadapp has also launched a Polygon version, but currently, the only supported protocol is Aave. Moreover, Instadapp only considers user usage needs and does not provide further asset management functions.

(2) Rich strategies with clear risk ratings for yield aggregation asset management functions

As mentioned earlier, the Matthew effect of funds can be expanded through supporting interest-bearing assets to enhance leverage and provide capital efficiency.

This can actually liberate the sunk funds in first-level needs. Therefore, an ideal asset management tool must have yield aggregation capabilities, allowing users to first pass their funds through this product before depositing them into first-level demand products. This way, they can enjoy basic returns while obtaining standardized interest-bearing asset certificates.

(3) Standardized interest-bearing assets

However, problems also exist. The risks of interest-bearing assets are closely related to the risks of the strategies themselves.

Still referring to the diagram:

Different interest-bearing asset strategies represent different risk-return profiles. For example, interest-bearing assets from stablecoin deposit interest have minimal price volatility, and deposit interest generally does not experience negative changes. Therefore, these assets can be considered the lowest risk. More complex strategies, such as:

Users deposit USDT into this strategy pool in Yearn, where Yearn will place the assets in the Aave pool provided by Curve, obtaining aToken interest + Curve fees + CRV + MATIC. Yearn will distribute all the returns obtained in a certain realization and calculate them as yield for yvUSDT.

In this process, three main protocols are involved, and active trading behavior occurs, significantly increasing the probability of risk.

For instance, protocol vulnerabilities, oracle price manipulation, etc. The risk rating of such assets should certainly be lower, and the minimum collateral ratio required when used as collateral should be higher.

Therefore, I believe: if our goal is to enhance the overall capital efficiency of the ecosystem and improve the composability within the ecosystem.

1: The first thing to do is to ensure that the interest-bearing assets of the product have a credible risk rating mechanism.

2: Secondly, the key indicators of interest-bearing assets must also be more standardized.

Such as constant quantity, providing stable pricing, transferable, and unrestricted withdrawal, etc.

3: Markable ownership of returns.

This is a point worth discussing. Suppose there is a scenario where a synthetic asset product expects to support a certain interest-bearing asset as collateral without making any targeted improvements; it must meet two conditions.

a) Constant quantity, providing stable pricing, transferable, and unrestricted withdrawal.

The reason for this condition is that if the interest-bearing asset contract does not provide stable pricing, and the synthetic asset protocol needs to calculate the value based on the interest rules of that asset, it could lead to situations where the liquidation value of the interest-bearing asset is lower than the actual asset value during liquidation.

However, the provided pricing also carries the risk of being manipulated, as seen in the recent theft incident involving Yearn's Cream protocol, where Cream directly obtained the pricing provided by Yearn when using yvASSET as collateral, and Cream's direct flash loan circular borrowing allowed hackers to control the pricing provided by Yearn, draining Cream's liquidity pool.

So, is there another way?

b) Interest-bearing assets with markable ownership of returns.

When users deposit interest-bearing assets as collateral into synthetic asset A, the synthetic asset protocol can disregard the impact of interest income on the overall collateral value. Because when depositing into the contract, the ownership of the returns can still belong to the user, and only when the collateral is liquidated will the returns be settled and the principal auctioned to the liquidator.

In this process, the synthetic asset platform does not need to treat interest-bearing assets specially; it only needs to return them in full upon burning or trigger return settlement during liquidation.

Moreover, as an asset management platform, there is no need to actively convert certain low liquidity platform token returns into high liquidity tokens. This way, the asset management platform does not need to provide pricing.

This form of interest-bearing asset resembles a combination of tokens and NFTs, which can be seen as a new type of markable ownership that is also splittable.

For this idea, we have also considered submitting a new EIP—token protocol standard. However, this solution also has some limitations.

For example, it would increase the complexity of the process during liquidation and would not directly reflect the value of interest-bearing assets in the debt (the appreciation of interest-bearing assets means that the proportion of collateral debt will decrease accordingly; the appreciation of interest-bearing assets is essentially using the returns from first-level demand protocols to repay debts for third and fourth-level products).

However, as mentioned earlier, consistent risk rating strategies and more choices mean enhanced composability, which I believe is very worthwhile to pursue.

04 Asset Management Middleware—Asset Management Middleware

In summary,

This product concept resembles creating a middleware for the ecosystem's assets, layering from first and second-level demand to fourth and fifth-level demand.

Users can have a one-stop basic demand function site, safely and reliably obtaining basic returns for their funds. Through this middleware, they can obtain standardized interest-bearing asset certificates with risk ratings, further enhancing capital efficiency.

Fourth and fifth-level demand projects can gain richer liquidity asset choices without getting caught up in the battle for existing funds with leading projects.

For projects facing similar issues as Polygon, they can fully leverage the liquidity foundation obtained from incentive programs and expand such products into a unified front for all funds through official support and guidance.

Special Statement: This article only discusses product design-related content and does not constitute any form of investment advice. Therefore, this article does not analyze market capitalization, market performance, or even economic systems in detail. Of course, if there are any disagreements regarding the research content, please contact SeerLabs.

About SeerLabs:

SeerLabs is a leading institution in Asia focused on blockchain market incubation. We possess cutting-edge marketing concepts and growth hacking strategies, dedicated to helping project parties and startups achieve rapid growth. We have successfully participated in the incubation of over 30 projects, including Polygon (MATIC), HoDooi.com, DIA, Paralink, Swingby, and XEND Finance.