Investment Thesis

● Levered bet on Curve (CRV), which has a solid fundamental catalyst with v2.

● Undervalued relative to Curve on a cost by cost basis. 1 Convex (CVX) = ~7. 4 CRV in voting power, so the current price should be north of $22.20 instead of the current price of $16.

● It captures the DeFi 2.0 narrative by monetizing governance and solving problems of mercenary liquidity and inflationary LP rewards coming out of new token supply emission. The market could expand its valuation due to this reason, as we have seen with Tokemak and Olympus.

● Supply squeeze as DAOs and VCs accumulate CVX to stake them for CRV rewards to bootstrap liquidity.

● Supply squeeze as users and retail investors buy CVX and stake them to earn bribes. These bribes are going parabolic and are paying close to $0.35 per locked CVX.

● Our model indicates the fair value (target price) of CVX being $29.40 excluding bribes and $38.30 including bribes.

Project Description

Curve Refresher

In order to understand the value proposition that Convex offers, we first need to refresh ourselves on how it works. Curve is an automated market maker (AMM) that specializes in liquidity pools with like-assets that are pegged to one another. Curve has liquidity pools with various stablecoins and pools with different flavors of wrapped or synthetic BTC, ETH, and LINK. It’s attractive to liquidity providers because users can earn yield in the form of trading fees without worrying about impermanent loss as long as the assets maintain their peg. In addition to trading fees, Curve rewards liquidity providers with its governance token, CRV. CRV tokens are interesting because users can lock up their CRV tokens for up to four years to receive vote-escrowed CRV, or veCRV. The longer that users lock their CRV tokens, the more veCRV they receive in exchange. Holding veCRV has three benefits: voting rights for the Curve DAO, a share of 50% of the trading fees on the Curve platform, and up to 2.5x boosted CRV rewards for liquidity provisions. Convex lets Curve liquidity providers boost their CRV rewards without locking their own CRV tokens.

How Convex Comes Into the Equation

Convex is a DeFi project built on top of Curve to facilitate higher returns for LPs and Curve stakers. It is an example of the compelling nature of composability in DeFi.

Curve liquidity providers benefit from Convex by receiving boosted CRV rewards made possible by other users who lock their CRV tokens with Convex. CRV holders irreversibly deposit CRV onto Convex and receive cvxCRV as a tokenized representation of their staked deposit. It should be noted that while converting CRV into cvxCRV is irreversible, one can swap cvxCRV to CRV via a liquidity pool on SushiSwap, though it is not guaranteed that they will trade 1:1. Users holding cvxCRV earn Curve trading fees and receive a share of the boosted CRV rewards that were made possible by the CRV that they locked. CRV stakers and liquidity providers also receive Convex's governance token, CVX, as liquidity mining rewards to further incentivize using the Convex protocol. Users can stake CVX on Convex to earn a share of protocol fees.

Current Market Position

Synergistic Growth

Convex's TVL has grown to $10.8 billion in six months by way of a synergistic relationship with Curve.

The swift growth in Convex's TVL shows a robust product-market fit. Convex is a compelling example of how composability in DeFi can create strong flywheel effects.

Based on the flywheel and leveraging tokenomics of Curve itself, Convex has captured 63% of Curve's TVL.

Convex also now controls ~45% of Curve governance. Importantly, those who deposit their CRV into Convex, as discussed earlier, are also surrendering control of it forever.

First-Mover Advantage

Some of the aggregators like Yearn and Badger, which were previously thought of as Convex competitors, have deployed anywhere between 40-70% of their AUM into Convex to stay competitive on their Curve-based strategies. This was primarily due to their high-performance fees. So now Convex can be thought of as Curve middleware. But if we dig further, Convex is also currently farming 65% of all Curve LP emissions as its control majority of the TVL locked in Curve. If Convex's consistent accumulation of Curve continues, it might end up capturing more than 50% of Curve's governance token and effectively be the largest stakeholder, having a monopoly over Curve governance.

Future Growth

As Convex owns the vast majority of locked-up CRV (45%), it carries the most voting power for the Curve protocol. But all that voting power no longer remains dormant. Convex can now monetize the governance power it has over Curve via the recent introduction of CRV Vote Incentives and Votium. Through these platforms, projects are bribing voters to grant their project's Curve pool a 2.5x boost. These bribes are also increasing. For example, last week's total incentives on Votium were $2 million. As a Convex holder, you have the power to vote with CRV on which gauges to boost rewards. This is why we are seeing DAOs bribing CVX holders with their native token to vote for them.

To get these bribes, CVX must be staked for 16 weeks. Additionally, for a lot of retail investors, gas fees could be steep in terms of reward received vs. gas fees paid, so they might let these bribes stack up and claim them later. While this could mean that CVX locked is, on average, longer than 16 weeks, which could put additional upward pressure on prices as the supply of CVX is taken off the circulation. We already see signs that CVX is being taken off exchanges.

CVX could be an interesting treasury asset for VCs because its voting power may let them bootstrap liquidity through Curve emissions for new projects. It can replace native token rewards that cause high token inflation for new projects and adversely impact the token economics of the project. However, VCs do have alternative options with stable liquidity provisions, using choices like Tokemak and Olympus Pro. That said, there is some indication that VCs are accumulating CVX. A quick glance at Nansen shows that Blocktower Capital aggressively accumulated CVX a few days ago, although it’s unclear whether the accumulation was for liquidity provision or earnings bribe rewards.

The assessment we have made thus far is that the CVX market position is tied to CRV. There are multiple reasons for this. Firstly, 45% of the CRV governance token is held by Convex DAO. Secondly, roughly 65% of Curve emission is captured by Convex Finance, and 63% of Curve TVL comprises Convex. Thirdly, the earnings that Convex generates for its stakers is in Curve (5% fees). Finally, yield aggregators like Badger, Harvest, and Yearn Finance want to take advantage of the Curve reward boost to deploy their strategies via Convex, letting Convex establish a moat (barrier of entry) on Curve-based strategies. Considering this, whatever is bullish or bearish for Curve is also bullish or bearish for Convex.

Reasons to be Bullish on Curve

The Curve will soon deploy its v2, which is a shift away from the pegged pools. This would let users swap between uncorrelated assets with tighter spreads and more capital efficiency. The first of these pools have already been launched, and it’s called tricrypto pool (WETH/WBTC/USDT). This pool lets users swap between ETH, BTC, and USDT. This pool has already been audited by Chainsecurity, and they found no critical issues, which makes us confident in the future execution of v2. Curve in this scenario will directly compete with Uniswap and be able to take market share from them and other DEXes in terms of annual DEX Volume. For reference, Uniswap has a fully diluted market cap of $27 billion vs. Curve’s $9.5 billion; there could be potential valuation catchup.

● Additionally, Bank of America also mentioned Curve in a recent report as one of the high yield options and DeFi blue chip for its institutional clients. This could mean that as smart money flows in, Curve might be among the top contenders for these flows.

● Curve arguably has less regulatory risk compared to its DeFi peers like Uniswap, as the contract was deployed by an anonymous third-party account. Also, the token allocation was fairly decentralized.

● Curve plays a key role in the DeFi ecosystem with major protocols such as Aave, Synthetic, Yearn Finance, Convex, and Compound building on top of it. Integrations with so many projects will give Curve an edge in maintaining market share, as it has a strong network effect.

● Their community is loyal. Curve has one of the longest lock-up periods in DeFi (average lock-up period of 3.7 years). Therefore, Curve token holders and LPs are vested in seeing Curve succeed for the long term as their motivations are aligned.

● CRV has a declining emission rate. There will be a scarcity of CRV emissions as we advance, which should be bullish for its price.

Reasons to be Bearish on Curve

● Future forks may dilute Curve's market share. A fork of Curve is available on other blockchains, such as Ellipsis on Binance Smart Chain or Equilibrium, building a cross-chain Curve implementation on Polkadot.

● User experience is poor. There is an education process involved in learning how to use the protocol, which may put off users who are unfamiliar with DeFi.

● Voting seems to be concentrated in the hands of Convex DAO; the duality of the same investment in CRV and CVX could lead to a contraction in CRV valuation.

Token Economics

Demand Side

Convex Finance’s native token, CVX, is a fee-earning token entitled to part of Convex's revenue from the platform's performance fees. Furthermore, CVX is distributed to Convex CRV stakers and liquidity providers. The protocol relies on an economic model that aligns incentives between liquidity providers and CRV stakers. The performance fees are entirely distributed to Convex users.

10% for CRV stakers

5% for CVX stakers

1% for the harvest caller.

As CVX is a fee-earning token, we can conduct price/sales and price/earnings comparisons for valuation in the later section.

Supply Side

CVX supply emission is not a function of time, as is common in most crypto projects, but is instead determined by the amount of CRV rewards that Convex farms.

At launch, the CVX/CRV mint ratio was ~450. This means that for every 1 CRV that was farmed, ~450 CVX were emitted. Now the mint ratio has decayed to 1.09 CVX for every 1 CRV farmed. Moving forward, this will continue to fall until the entire supply of 100 million CVX is emitted at a decreasing rate.

Notably, CVX issuance had played a key role in juicing overall returns and bootstrapping the adoption of CVX.

But when CVX issuance tapers, the current APY might not be attractive. We can even estimate when the CVX reward will be exhausted. Assume the following:

● A take rate of 65% of CRV rewards accrued by Convex DAO

● Current mint ratio of 1.09 of CVX vs CRV

● Daily supply emission of 750,000 CRV

● 1:10 ratio of CVX: CRV

Based on the above assumption, we can approximate that the CVX rewards would be exhausted two years from now. Although we are assuming the mint ratio remains constant, it is, in reality, a decaying function, but it does highlight that the slow down in CVX emission would decrease the APY unless the price appreciates compensating this offset. That said, assuming Convex can continue earning 65% of CRV emission over these two years, it would end up having substantial control over Curve governance given the staked veCRV it would accrue. This will allow Convex to continue boosting the yield it is receiving from Curve, even as the incentives derived from its token (CVX) diminish.

Token Allocation

CVX has a maximum capped supply of 100 million, and it's reasonably decentralized. This means the value accrual is widely spread out rather than concentrated in the hands of the team and investors, so they will enjoy a strong network effect.

The token distribution is as follows:

● Curve LP Rewards – 50% of CVX's supply will be distributed pro-rata to the CRV revenue received on Convex;

● Liquidity Mining Rewards – 25% of CVX's supply will be distributed to liquidity programs over 4 years;

● Treasury – 9.7% of CVX's supply is allocated to Convex's treasury vested over 1 year. ● veCRV Holders – 1% of CVX's supply was distributed to veCRV holders as an instantly claimable airdrop;

● Convex Whitelist Vote – 1% of CVX's supply was distributed to veCRV holders who voted to whitelist Convex;

● Investors – 3.3% of CVX's supply was allocated to investors who pre-seeded Convex's boost and locked their CRV (with no cvxCRV minted), these funds are vested over 1 year;

● Convex Team – 10% of CVX's supply was allocated to Convex's Team; these funds are vested over 1 year.

Relative Valuation

Yield generating protocols in DeFi based on Curve can be thought of as our comparable set for valuation. DeFI projects with attractive token economics designs that create flywheel effects are one more comparable set. Additionally, protocols that provide liquidity as a service could be another point of comparison as VCs can theoretically use CVX as a treasury asset to boost liquidity via CRV’s 2.5x boost.

Competition

Comparisons with Yield Aggregators

Although CVX remains expensive to other yield aggregators like Yearn on a fully diluted valuation (FDV) basis, it remains the most inexpensive if we consider the total value locked. At current valuation, for every $1 locked in value, the market is attaching a valuation of $0.14, which is almost four times cheaper than Badger.

Comparison with projects that have a similar flywheel and tokenomics

Comparing Convex Finance to Pickle Finance and Adamant Finance, a similar story emerges: Convex is cheaper when total value locked is considered. Note that these projects are not perfect comparables but have similarities in unique tokenomics and flywheel effect. For example, Pickle designed a system to increase yields of Yearn deposits through the additional issuance of PICKLE tokens, which is similar to what Convex did on Curve.

Comparison with Liquidity as a Service (LaaS) Providers

Convex appears nearly 90X undervalued relative to Tokemak on FDV to TVL ratio.

Comparison with Curve

Remarkably, if one is bullish on Curve, Convex DAO controls 46% of its governance token – this implies a fair valuation of $4.3 billion and a 2.8x ROI potential. So one thesis could be if one is bullish on Curve, play it with Convex tokens. That said, the market could be attaching a discount to Convex relative to other protocols because Convex's destiny is intrinsically intertwined with the success of Curve and its ability to accrue value from its trading fees. In contrast, other aggregators can swiftly change strategy away from Curve or Convex to another protocol and are not entirely dependent solely on Curve.

Financial Analysis and Valuation

Price-to-earnings and price-to-sales comparison

Since Convex is a fee-earning token, we can conduct price/sales and price/earnings comparisons with other fee-earnings tokens within the sector to shed more light on its valuation from a different angle.

Based on price/sales, Convex is cheaper than Badger, but Convex is expensive relative to Yearn Finance. The reason could be that Yearn has superior revenues because they charge their users a 20% performance fee on gains and a 2% management fee on the deposited capital. By comparison, Convex only charges a 16% performance fee. Another reason why Yearn might be cheap is due to the fact that it is just a governance token, and CVXs token utility is superior. Hence, the market might be correctly attaching a lower valuation. However, if we consider bribes as part of earnings, Convex appears to be a deep value play at a mere 6x P/E and significantly cheaper than Yearn. Just a point of reference, Nasdaq (US tech stock index proxy) P/E is 38x.

Valuing Network Effect

Instead of using the current revenue and earnings of the protocol – if we tried to gauge the network effect by proxying the Discord community, we see that Yearn and Badger are both more expensive than Convex. We have used Discord to proxy the network effect because it has a nice balance of developers, users, Discord followers, which are relatively more genuine (unlike Twitter). We believe Convex has an attractive network effect value because not only is the project relatively decentralized, but the token utility has created an appealing flywheel leading to better adoption.

Intrinsic Valuation and Scenario Analysis

The assessment we have made thus far is that CVX valuation is tied to CRV.

Suppose we take the average P/E ratio of Badger and Yearn Finance, 45x, which could be assumed as a fair multiple for yield aggregating projects. If we attach a 20% discount to this ratio as Convex Finance has customer concentration risk, CVX's earnings are tied to Curve emissions. The fair multiple should be around 36x P/E, and Convex is currently trading at 25x P/E, approximately a 44% valuation discount.

Considering the fair P/E multiple of 36x, the range of Curve Emission take rate, and Curve price, we estimate a target price range for Convex Finance (on current market cap basis) below. The sensitivity analysis is critical as it shows how value drivers impact our valuation. Here the value drivers are the Curve price; Curve emission takers rate and P/E.

In the tables below, we have tested our target price by changing:

● Curve price

● Curve emission take rate

From the current price of $20, there is a 35% to 72.5% upside if CRV price remains between $2.75 to $3 and the emission take rate is between 60% to 70%.

In the next tables below, we have tested our target price by changing:

• Curve price

• P/E ratio

From the current price of $20, there is a 22.5% to 78% upside If the CRV price remains between $2.75 to $3 and the market assigned P/E ratio is between 30x to 40x.

In the analysis above, we have not considered bribes in the earnings; in the following analysis, we will keep P/E constant and emission rate constant and take bribes as part of earnings. Note that bribes are currently around $2 million biweekly, which is annualized to be $50 million. We will also consider the total CVX supply rather than the circulating supply as we did above. From the current price of $20, there is a 66% to 123% upside If the bribe remains between $40 to $60 million, other things being equal.

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