Drift ($DRIFT) Analysis and Valuation - the Binance moment for derivatives DEXs.
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EXECUTIVE OVERVIEW
Multicoin has accumulated a large position across our funds—both liquid and
venture—in DRIFT, the native token of Drift, a derivatives decentralized
exchange (derivatives DEX) on Solana. We built the position over the last few
years via private and more recently, via public markets as well. We have long
believed in the opportunity for Open Finance, which we define as making all
units of value—including, but not limited to, stocks, bonds, real estate, and
currencies—interoperable, programmable, and composable on distributed ledgers,
thus making capital markets more efficient and accessible to everyone on the
planet. Open Finance, and by extension decentralized finance (DeFi), is one of
our three Crypto Mega Theses. The biggest opportunity in Open Finance is a
protocol which is built to allow anyone anywhere in the world the ability to
trade any asset. The executive summary of our DRIFT thesis is as follows:
1. We believe that the most successful derivatives DEX needs to be built on an
L1 that has other assets issued on the chain. We do not think that appchain
derivatives DEXs will win because they will never be as performant as
centralized exchanges (CEXs), nor will they be able to compose with other
programs and assets on a general-purpose chain. They do not benefit from
ecosystem flywheels that exist on generalizable L1s.
2. Drift has a unique exchange construction that enables three types of
liquidity provisioning: dynamic AMM (DAMM), decentralized central limit order
book (DLOB), and just-in-time (JIT). We previously wrote about the trade-offs in
the design space of derivatives DEXs here and believe Drift has chosen the
optimal set of trade-offs.
3. Drift’s core metric—total volume across derivatives, spot, and swaps—is up
~50x year over year, and the protocol’s market share in the derivatives DEX
sector is up ~10x in that time.
4. The Drift team is relentless and constantly ships new products and features.
Beyond a derivatives DEX, they are building a capital efficient DeFi platform
that expands beyond synthetic trading. We believe Drift could be a DeFi
“superapp” due to its ability to cross sell trading products to users.
5. Solana adoption is growing extremely quickly, and we are witnessing a secular
growth trend across all Solana DeFi applications. Drift will disproportionately
benefit from significant ecosystem growth tailwinds because we believe it’s the
best constructed derivatives DEX on Solana.
6.The Drift team has the privilege of focusing 100% of their efforts on product
rather than infrastructure. This is only possible because Solana is scaling
without any input or thought from the Drift team. Being on Solana allows the
Drift team to focus on product in an integrated, composable stack, vs the
complexity and bridging of a modular environment. As the Solana network
continues to improve (e.g., the introduction of Firedancer and Agave clients and
other network upgrades), the developer experience and infra layer Drift lives on
gets better without any engineering effort from the Drift team or other
contributors.
a. Note - this is the ideal expression of modularity in software systems.
Systems should naturally improve over time without developers having to think or
act at all.
7. Based on our valuation framework and assumptions, which we outline at the
bottom of this report, we value DRIFT in our base case at $3.58, more than 7x
above its current price.
MARKET ANALYSIS
THE OPPORTUNITY FOR DERIVATIVES DEXS
The vast majority of crypto’s big implosions in 2022 (i.e., FTX, BlockFi,
Voyager, Celsius, Genesis) were centralized institutions. These centralized
products generally go against the ethos of crypto; crypto is about empowering
users all over the world to have more control over their assets by leveraging
open and transparent systems. DeFi protocols, such as AAVE, Compound, Maker,
Hubble, Uniswap, Orca, etc., all performed flawlessly during 2022 despite the
massive volatility. This, to us, reinforces the efficacy and importance of DeFi.
Source: The Block
Over the past 12-24 months we’ve witnessed an explosion of DeFi activity on
Ethereum/L2s and Solana. This wave of activity has been primarily driven by
lending platforms (e.g., Aave, MakerDAO, Kamino, marginfi) and trading platforms
(e.g., Uniswap, 0x, Orca, Phoenix, and Raydium). This is because—while clearly
an important idea—DeFi, in its current incarnation, is mostly just a mechanism
for going margin-long SOL, ETH, ARB, OP, SEI, APT, etc., and other DeFi tokens
and memecoins. Market consensus has quickly converged on the idea that DeFi—at
least for now—is “just” open and non-custodial Binance/HTX/Deribit. However, if
you look at the data in the chart above, even in its current form, DeFi has been
growing faster than CeFi.
DeFi traders today primarily access leverage through lending protocols and spot
DEXs. For example, a trader can post $150 of SOL as collateral on Kamino, borrow
$75 of USDC, and then trade that USDC on any market or DEX for $75 worth of SOL
(the asset deposited as collateral). This allows her to hold $225 worth of SOL,
thus giving her a higher level of exposure to the price movements of SOL. She
has $225 of SOL and owes $75 of USD denominated debt (represented by the USDC
she borrowed).
The current model has a few notable limitations: (1) traders are capped on
leverage because most DeFi lending protocols require >133% collateralization (on
non correlated pairs), and (2) because traders must borrow and sell spot assets,
they can only lever up—or short sell—Solana native assets if the borrow/lend is
on Solana. This is also true if the borrow/lend protocol is on Ethereum; they
can only lever up on Ethereum native assets. There are varying solutions to this
problem, most notably bridged assets, but bridges continue to be the largest
security risk in crypto. Even in Solana, which is one of the most capital
efficient ecosystems, only ~$826M of the ~$3B that was being lent on margin
protocols (as of September 2024) was being borrowed, leaving ~$2.2B idle (we
understand the capital sits there so that lenders can redeem with no term).
It is clear there’s demand for this type of spot leverage; however, in order for
other real-world assets to be traded on chain in any reasonable timeframe,
crypto markets need derivatives. A derivatives venue can allow anyone in the
world the ability to trade any asset, whether a traditional asset or digitally
native asset.
THE ROLE OF PERPETUAL SWAPS
Today, the most liquid financial derivative in crypto is the perpetual swap
contract, and for good reason: the “perp swap” is one of the most important and
elegant contracts in modern-day finance. Popularized by BitMEX, perp swaps now
trade >$100B per day across all the major CeFi derivatives exchanges. Perp swaps
have become widely popular because they afford several advantages over other
forms of financial contracts:
● The futures contract never expires, meaning traders can keep it open
“perpetually.” They do not need to worry about rolling over their positions.
● Perp swaps are entirely synthetic, which allows any collateral type for any
position.
● Via a clever mechanism known as the funding rate, perp swaps track their
underlying prices more closely than dated futures contracts.
● They can be more easily traded with leverage than spot.
As shown in the chart above, DEX spot volume is currently ~12% of that of CEX
spot volume. On the other hand, DEX derivatives volume is currently ~5% of that
of CEX derivatives volume:
Source: The Block, DefiLlama
We think most crypto derivatives traders today are (1) more sophisticated than
spot traders, or (2) overleveraged speculators. Highly sophisticated traders
care a lot about fill price, execution, latency, etc, and are thus served
better—right now—by CEXs. The levered speculators tend to go where it is most
convenient, and for most traders that means CEXs. As a note, Binance reported in
early 2020 that 79% (!) of perps speculators used >20x leverage, implying heavy
retail participation.
That perp swaps have completely dominated CEX trading tells us something:
traders prefer speculating on highly leveraged synthetic contracts over spot
margin trading. And that is on centralized exchanges where those companies can
allow deposits for every blockchain-based asset as collateral. These assets are
liquid and can be borrowed and posted for spot margin on CEXs, but users prefer
stablecoin margined perps over posting any of these as collateral or borrowing
them. Traders on Solana do not even have the luxury of “depositing” BTC, XRP,
BCH, LTC, DOGE, etc. as collateral (in a trust-minimized way), and thus
perps—which allow anyone to lever up on any asset, with any form of
collateral—are best positioned to win leveraged trading on Solana.
As it relates to derivatives DEXs, unlike spot margin, perp markets only require
three core functions:(1) a matching and risk engine, (2) an oracle, and (3) an
asset (stable or volatile) for margin. Because they are entirely synthetic, not
only can perp exchanges accept any form of collateral, they can also enable
trading on any asset (forex, commodities, equities, crypto, prediction market
events, etc.).This makes them the ideal instrument for financial inclusion.
There is significantly less counterparty risk in spot trading than there is in
derivatives trading. If Alice owns USDC, and wants to sell it for SOL, she can
deposit it into a CEX, sell it for USDC, and withdraw it all in a matter of
minutes (dependent on confirmations, withdrawal times, etc.). However, if she
wants to open a derivatives position for some extended period of time, she must
hold her collateral on the CEX in order to maintain her margin and keep her
position open. As such, there is substantially more counterparty risk when
trading derivatives as opposed to trading spot.
In the future, we believe that more and more retail users will get web3 wallets
for reasons that are explicitly not speculation. This could include stablecoin
payments, DePIN earnings, etc., as discussed further in this report. They will
want to be able to trade any asset (forex, commodities, stocks, crypto,
prediction markets, etc.), and find structures that help them hedge earnings
(e.g., a Helium miner using HNT perps to hedge their future earnings). And the
most convenient place to trade everything in a composable way will be on
derivatives DEXs—specifically through perps.
CEXs (rightfully or wrongfully) are becoming slower and more rigid about their
listing standards. If you want to trade a long tail asset then DEXs are the only
place to go. CEXs also generally block users from jurisdictions (see, e.g.,
Binance prohibited jurisdictions) if their platforms include perpetual swaps.
While many DeFi front ends, including Drift, geoblock regions including the
U.S., there is a massive opportunity for derivatives DEX protocols to fill the
gap by offering permissionless access and faster token listings for users that
are currently boxed out of the system.
To get a sense of the potential scope of the TAM for a derivatives DEX, just
think about how many trades are economically worthwhile but do not happen
because of trust or access issues.
Permissionless access across borders expands access to global financial markets
to billions of people around the world who do not currently have access. In the
ideal future case for DeFi, anyone anywhere in the world will be able to trade
any asset they want. This is extremely market expansionary (the market does not
fully appreciate just how big this market could get). As billions of people come
online in the developing world and need access to financial markets, they will
seek out derivative DEXs. DEXs ensure that no exchange operator or politically
motivated regulator can unilaterally change the rules of the exchange – meaning
that traders all around the world can be comfortable trading on the same venue.
We believe the derivatives DEX market will be a winner-take-most market due to
the strong network effects of liquidity. We also expect them to cannibalize
market share from centralized incumbents due to their ability to cut costs and
pass those savings on to traders; DEXs don’t require large customer support
teams, localization, universal deposits/withdrawals and custody systems, etc. In
order to grow into the world’s default trading venue, it’s very important that
teams make the right set of trade-offs early, and to get the flywheel started by
attracting liquidity providers and takers. We think Drift has gotten it right,
and the results will compound.
MARKET COMPETITION: COUNTER THE STATUS QUO
The idea of derivatives DEXs is not new. UMA wrote the BitDEX paper in October
2019. Initially, derivatives DEXs were on Ethereum L1. Then they gradually moved
over to Ethereum L2s (e.g., GMX on Arbitrum was the dominant derivatives DEX of
the last cycle).
More recently, there has been a large structural move in the derivatives DEX
market towards dedicated chains for DeFi derivatives, otherwise known as
“appchains.” We do not view appchains as the correct approach for derivatives
DEXs long term because they suffer from a lack of composability—both on-chain
and off-chain forms of composability. They also are overly reliant on central
points of failure and bridging infrastructure (they either lack native
stablecoin support and/or don’t have third-party issuers that launch net new
tokens on their chains). Additionally, they are limited in their ability to
support native tokens as collateral, either because they don’t have independent
third-party tokens and/or because the tokens on their chains are extremely
illiquid.
The most well-known derivatives DEX protocol on an appchain is Hyperliquid. We
contend that it is not practically a derivatives DEX because of the opaque
nature of the validator set; it’s fast today but can be censored tomorrow. To
our knowledge, Hyperliquid is an on-chain CLOB in which the validator set is
made up of a limited set of validators run by the core contributors.
If a team builds a dedicated appchain for derivatives DEXs, they introduce a
tremendous amount of friction. They need to convince users to get new wallets,
they need to persuade stablecoin issuers to issue natively on their chain, they
do not benefit from ecosystem flywheels that exist on general-purpose smart
contract chains (e.g., a slew of tokens that can be used as collateral in the
derivatives DEX, apps to compose with, users with funded wallets), and so on.
Some people will claim that dYdX, Hyperliquid, and other large derivatives DEX
competitors can’t possibly lose market share to a more compelling
alternative—“they are too entrenched!” Unfortunately for them, history is not on
their side; dominant CEXs have not stayed on top forever, and it is not uncommon
for liquidity to migrate to better products. Before Binance, market share was
fickle for CEXs.
Source: Bitcoinity
Binance created a one-time shift in the CEX market because they offered an
extremely compelling product that integrated trading products and united them
under a token. They launched the exchange in July 2017, and by 2018 they were
the largest crypto exchange globally, with 5x more market share than any other
“real 10” spot competitor. Market share can restructure faster than most
realize.
Source: CoinAPI
We believe Drift will be the Binance moment of derivatives DEXs. We called that
shift in our original BNB report in 2019, and we are calling it again today with
DRIFT. In recent times, market share has been fleeting and various derivatives
DEXs have been dominant at different times:
Source: The Block
As the market begins to appreciate the elegance of Drift, we think their market
share chart will look similar to Binance after they launched.
DRIFT EXCHANGE
A BRIEF HISTORY OF DRIFT
We initially invested in the seed round of Drift in July 2021. The founders,
David and Cindy, presented a compelling idea to build a global derivatives DEX
on top of Solana utilizing a “dynamic AMM” model (DAMM). This sidestepped the
need for professional Market Makers (MMs), who at the time were hesitant to
provide on-chain liquidity on any chain, much less a newly launched chain like
Solana was at the time.
The team launched Drift V1 to Solana mainnet beta in November 2021—effectively
the top of the 2021 cycle. Incredibly, they reached $1B of trading volume in
just 39 days, faster than FTX, Bitfinex, Coinbase, Uniswap, and other powerhouse
exchange brands.
From there, they swiftly launched limit orders and maker orders in early 2022,
and continued iterating on the product. Then, disaster struck.
During the collapse of Terra LUNA, a bug was found in the Drift protocol that
created a shortfall. Fortunately, the Drift team reacted quickly, patched the
bug, and rolled out a reconciliation plan to compensate impacted users. With the
stumble behind them, they quickly began work on Drift V2, a complete
reimagination of the product that expanded liquidity provisioning from just a
DAMM to a DLOB, DAMM, and JIT. They also completely redesigned the risk engine
and P&L settlement layer from scratch.
They deployed Drift V2 in November 2022, shortly after FTX collapsed and when
Solana was most vulnerable. The Drift community, known as Driftors, stuck with
them and continued to trade. And in May 2023, they announced a $23.5M funding
round led by Polychain to help fuel growth and continue the momentum. Since V2
went live with the new liquidity provisioning and redesigned settlement layer,
the protocol's performance has exceeded expectations, even through severe market
volatility.
As investors, we look for intangibles. It is important to recognize how much of
a slog 2H of 2022 and 1H of 2023 were for Drift. Solana was reeling from FTX,
there was broad apathy from the bear market in crypto, the Solana network had
recently halted several times, and maker-side liquidity was crushed across all
of Solana DeFi. However, the team persisted. They did not shift strategy or
abandon the Solana ship due to outages. Additionally, they did not give up on
their derivatives DEX vision because of a V1 bug. They kept going where others
would have easily quit.
We think persistence is a critical attribute for successful entrepreneurs. The
Drift team has gone through a ton of adversity to get to where they are today,
and they deserve every inch of it.
DRIFT’S LIQUIDITY PROVISIONING
Blockchains are always going to be slower than CEXs because of the inherent laws
of physics. As a result, all derivatives DEXs that only support central limit
order books (CLOBs) have historically suffered from worse execution than what
you might see on Binance, OKX, Bybit, etc. MMs are worried about latency,
because it can lead to stale maker orders being picked off before they can be
canceled; therefore, they have to quote wider spreads to account for this
uncertainty.
Drift is a derivatives DEX that lives on top of Solana. Drift’s primary novel
feature is that it is supported by three types of liquidity provisioning, which
help create tighter spreads, more reliable liquidity, and faster fills:
1. Just-in-Time (JIT) auctions — MMs can fill user market orders in a Dutch
auction style format over some short time frame.
2. Decentralized CLOB (DLOB) — traders can place limit orders, and a network of
keepers monitors these orders and execute them against the AMM or other limit
orders (these keepers earn a % of the trading fee).
3. DAMM liquidity — if market orders are not filled by MMs, a DAMM pool provides
the last layer of liquidity.
In late 2023 and early 2024, DAMM fills were the primary source of liquidity.
However, in February 2024, Drift launched the Drift Market Maker Program, which
resulted in major crypto MMs integrating via Drift’s APIs. This resulted in a
significant shift from passive to active liquidity.
Source: Top Ledger
For mature markets, like SOL and BTC, we expect to—and want to—see more active
liquidity (JIT + CLOB) because MMs are willing to quote those assets in size. In
fact, active liquidity now makes up ~70% of SOL trades on Drift perp markets.
Newer markets, like POPCAT and CLOUD, are more likely to have higher DAMM
reliance (similar to Uniswap being the primary venue for newer, more long tail
tokens on Ethereum). The net result is that MMs are quoting for large caps,
providing better spreads than the DAMM would. The DAMM is acting as a backstop
liquidity source, enabling perpetual trading for smaller assets that MMs are
reluctant to quote. This is the beauty of Drift’s hybrid model, and it is
optimized for both large cap and small cap tokens.
DESIGNING A DERIVATIVES DEX FROM FIRST PRINCIPLES
We wrote an essay titled Trade-offs in the Derivatives DEX Space in September
2020. If you have not yet read it, we suggest browsing through it before reading
the rest of this report. In that report, we wrote:
“The primary objectives for a [derivatives DEX] protocol are:
1. Having very liquid markets
2. Enabling moderately high leverage
3. Keeping the contract mark price close to the fair asset price at all times
4. A robust liquidation engine that protects against insolvency and socialized
losses
5. Offering the lowest trading costs (at the application and protocol level)
6. Low latency trading
7. Supporting a variety of convenient and stable collateral types
8. Cross-margining positions
9. Ability to offer synthetic exposure to arbitrary assets and contracts
10. True on-chain decentralization, or at least full transparency
In our view, the best way for a synthetic DeFi platform to attract liquidity is
to optimize for the ten features listed above. However this is complex and there
are many tradeoffs that must be considered.”
Drift is the first instantiation of this thesis that we have seen that offers
all of these features. Let us go through them in order:
1. Liquid Markets — Drift is supported by three liquidity-provisioning methods,
as described above (JIT, DAMM, DLOB).
2. Available Leverage — Drift supports up to 20x leverage for large cap assets,
and 5-10x leverage for longer tail assets.
3. Mark Price to Fair Price — With more MMs integrating Drift and Solana, they
will arbitrage funding rates between Drift and large CEXs that currently
dominate market share. This is a case where Drift benefits from the broader
Solana ecosystem because if an MM integrates one Solana DeFi protocol, it
becomes substantially easier to integrate another one.
4. Liquidation Engine — since Drift V2’s inception in November 2022, there has
been ~1.5M liquidations across perps and spot (per this Dune dashboard). The
insurance fund in that time has grown from 0 to $28M today.
5. Low Trading Costs — Solana’s fees are lower than those of other major chains
which have derivatives DEXs. Fees at the application layer are easily tunable
and will respond to market conditions.
6. Low-Latency Trading— for on-chain derivatives DEXs, Drift is very
competitive, though it struggles against off-chain CLOB models (instead opting
for more composability).
7. Multiple Collateral Types — Drift currently accepts 25 assets as collateral,
spanning both stablecoins and volatile tokens (at varying collateral
weightings). dYdX and Hyperliquid only support USDC as collateral. Jupiter
allows virtually any asset with no haircut. When we tested the Jupiter platform,
we were able to use Jason Derulo’s celebrity coin as margin.
8. Cross-Margin Platform — every product on Drift is cross margined. So if Alice
lends on Drift’s borrow/lend market, that position can be considered towards her
collateral on perp markets. She can also use the same collateral intra-product
across markets.
9. Synthetic Assets— Drift recently launched Drift BET, a prediction market that
works the same way as its perps market. We expect that, over time, Drift will
enable trading on all kinds of assets (commodities, forex, equities, etc.).
10. Decentralization — the entire Drift stack is on Solana, and it is open
source, ensuring complete transparency and permissionlessness. This stands in
stark contrast to appchain DEXs, particularly those with off chain order books.
We believe Drift is closest to feature parity with the large derivatives CEXs
that drive most of the perps volume in crypto today. We expect them to continue
iterating on the core perps product, and they have the correct construction
based on first principles (three types of liquidity, and built in an open and
transparent way) to continue innovating and taking market share.
Operating a global cross-margined risk engine becomes exponentially more risky
and complicated on an appchain. These protocols have to account for the
viability and stability of various forms of pegged assets and apply haircuts to
virtually every asset used as collateral. Integrated chains like Solana are more
likely to have native liquid assets that can be used as collateral, which are
generally much safer vis-à-vis the same liquidity and market cap, and thus
require lower discounts. As a result, Drift can be much more capital efficient
for traders who get more “money for their margin”.
Alongside the core perpetuals exchange, the Drift protocol features other unique
products. There are many sources of yield within Drift: borrow/lend, insurance
fund staking, Circuit vaults, DLP, SuperStake, etc. You can imagine that they
will add additional automated yield products in time that dynamically rebalance
user deposits towards the best risk-adjusted opportunities on Drift.
Drift has evolved into a collateral platform upon which any DeFi derivative can
be built. This enables traders to seamlessly collateralize their crypto, forex,
prediction markets, commodities, etc., positions using a single global margin
account. And those traders will be able to match trades against anyone in the
world that has an Internet connection.
THE CAPITAL-EFFICIENT DEFI PLATFORM
On-chain Composability
We published our initial BNB thesis in February 2019. The crux of the thesis
(besides Binance growing spot market share) was they were starting to build out
an entire suite of products that catered to their existing user base, including
Binance chain, derivatives, spot margin, fiat exchanges around the world,
options, etc. This enabled Binance to go from effectively nothing to the world’s
largest crypto exchange in a matter of six months.
Drift is the Binance moment for DeFi. The application started with perps and
spot trading, added borrow/lend (as an aside: they are #2 on Solana in terms of
borrow/lend assets), and most recently added a prediction market product. There
is a clear opportunity for them to add options, RWAs, liquidity provisioning
vaults, yield optimizers, stableswap functionality, and more over time. We
expect that all of these will magically compose with one another, and the
existence of each will improve capital efficiency and execution for makers and
takers. As an example, Alice can use a long BTC spot position to go short TRUMP
token in Drift’s prediction market (hedging her BTC position against that
specific event outcome using BTC as collateral). Were she to use Polymarket, she
would need to own BTC on a separate venue, and then also hold USDC as collateral
to short TRUMP. Drift is much more capital efficient in this scenario, and
traders will also flock to where capital is most efficient.
As they continue to build out new products, Drift will look more and more like a
CEX. In fact, their north star is feature parity with Binance, in a
non-custodial way. We expect Drift to become bigger than the major CEXs over a
long enough time horizon.
The challenge with Binance, and other CEXs generally, is they are all zero-sum
and compete viciously with each other for users with little to no room for
collaboration. By way of illustration, some of the top CEXs globally—with the
exception of Coinbase—are very opposed to supporting solutions like Copper’s
ClearLoop because offshore CEXs want user lock-in by requiring traders to
custody with them. A global cross-margining system for CEXs would eliminate a
lot of market dislocations and improve capital efficiency for large traders and
MMs across the crypto ecosystem, but CEXs have displayed no interest in enabling
this. We highlighted this dynamic and its problems in our March 12, 2020
retrospective.
Unlike CEXs, there is a strong incentive for collaboration among DeFi protocols
because better products (even if you do not benefit your own protocol directly)
bring more users on chain, which leads to more ecosystem momentum, which leads
to more potential users of your application. Ask yourself this: how often do you
see Bybit, OKX, Binance, and HTX collaborate? And how often do you see DeFi
teams on Solana collaborate? Amazingly, because Drift lives on chain, it’s not
hard to imagine a world where they cooperate with all kinds of other DeFi
applications (alongside their own in-app composability).
We see a world in which a new crop of prime brokers (PBs) pop up that are
DeFi-native. Looking back at the collapse of Three Arrows Capital, and even
Archegos Capital in TradFi, the problem was that none of the lenders knew the
size of the borrowing hedge fund’s positions across all brokers, their
correlations, and their overall risk. In DeFi, we could see specialist PBs
extend credit on chain that are algorithmically bounded. For example, a PB could
enable a market neutral fund to deploy a basis yield strategy on Drift in an
undercollateralized way, but the capital would algorithmically be constrained to
move to Drift (and other whitelisted protocols and contracts). The PB would have
full visibility into the lent funds and liquidate them at a layer above Drift
should they need to.
The opportunities for on-chain composability with other protocols is effectively
boundless, and we are just now starting to see what can happen with global,
permissionless finance APIs.
Off-Chain Composability
We briefly touched on on-chain composability before, but an underrated form of
composability for Drift is off-chain composability. We define on-chain
composability as DeFi legos. We define off-chain composability as the benefits
an app gets by being part of a broader ecosystem.
Here is a simple example of off-chain composability: a new user to the Solana
ecosystem can receive SOL via TipLink, a low-friction onboarding experience that
allows anyone to send a money link to anyone else. The onboarded user can easily
buy a Helium hotspot and start earning HNT rewards. She can swap her SOL on
Jupiter for USDC, then deposit the USDC into Drift, and hedge her future HNT
earnings. Upon receiving HNT rewards, she can swap them for USDC, make a wager
on Drift BET (Drift’s prediction market), and then transfer her Drift BET
winnings to purchase an NFT on Tensor. She can do this all with one wallet
natively on the Solana blockchain.
If the DEX aggregator was on Optimism, but the derivatives exchange was on
Arbitrum, and the DePIN network was on Base, she would have to bridge at every
step, incurring a large amount of latency and slippage costs. The user flow
would break entirely.
The biggest bottleneck to growth in crypto, and DeFi more specifically, is
getting wallets into the hands of millions of users. We have long said DeFi is a
second-horizon activity. Once users have funded non-custodial wallets—and do not
need to buy SOL, ETH, etc. on Coinbase and then withdraw it to a wallet—they
will use DeFi because it is the cheapest and most convenient financial rails for
them. As an example, Helium miners were at one point 10% of Jupiter users.
We think Solana has the best shot of onboarding millions of users and getting
them wallets (of which they only need one!), and thus Drift will
disproportionately benefit from that because any user with a Solana wallet can
tap into Drift’s liquidity with no bridging, new wallet, etc, required.
DRIFT’S GROWTH STORY
Drift has grown tremendously since emerging out of the brutal 2022 bear market.
The team has relentlessly shipped since then and perfectly encapsulated a
phoenix rising from the ashes (we like those at Multicoin).
Approximately $5B was traded on Drift across perps, spot, and swaps in August
2024, representing an increase of 50x(!) in volume year over year—cumulative
volume across perps, spot, and swaps in August 2023 was ~$97M. This is the most
important metric for Drift because running an exchange and matching service is
an extremely high margin business, and it is the core product offered by Drift
today. Significantly, the majority of the increased activity has come from
perps.
Source: Top Ledger
While volume growth is important on an absolute basis, it is also worth
considering whether Drift’s market share is growing. In their most important
market (perpetual contract trading), Drift has ~10x’d their market share against
competitors over the last 12 months. On an absolute basis, their market share is
still small (2.2%), which leaves ample room for growth.
Sources: The Block, Top Ledger
Relatedly, Drift’s insurance fund has grown from ~$1.5M at the end of July 2023
to over $20M of USDC and SOL at the time of writing (with another $5M of DRIFT
staked that is not included in the chart because the token recently launched and
it would bias the chart upwards, and $3M of other less liquid tokens also not
included).
Source: Top Ledger, Investing.com
“Total Value Locked” (otherwise known as TVL) is not a perfect metric; in fact,
in a lot of cases it can be counterproductive (e.g., too much TVL for a spot AMM
relative to taker volume implies a capital inefficient protocol). However, the
collateral sitting in Drift, both for lending and derivatives margin, is useful
to track. We think it is relevant to look at SOL-denominated TVL (though the USD
denominated TVL chart looks similar), because underlying price volatility does
not skew the data.
Source: Artemis, Investing.com
We include all of these charts to make a specific point, which is that the
existing Drift product suite is a growth story. Even after the DRIFT airdrop,
which occurred on May 16, 2024, Drift’s core protocol metrics are still going up
and to the right.
As we elaborate further below, we think there will be a liquidity migration from
Ethereum and L2s, as well as appchains, over to Solana, and Drift is best
positioned to capture that liquidity for derivatives. As such, we expect these
metrics to continue increasing.
THE SOLANA TAILWIND
Multicoin has been investing in early-stage crypto projects and public tokens
for seven years. We have looked at every “hot new” category that has emerged,
and our primary conclusion after this time is that public blockchains are
primarily useful for two things: 1) trading and 2) payments. And the most
important considerations when building a trading or payment application are 1)
latency and 2) cost.
Across the entire L1, L2, and L3 landscape, we have repeatedly held that Solana
provides the most clear way to get low latency and low cost without sacrificing
composability.
Going into Solana’s annual developer conference—Breakpoint—in November 2022
(just prior to the collapse of FTX), we were quite excited about Solana. We
thought the ecosystem had matured to a point that it could present a credible
challenge to Ethereum. Unfortunately, the FTX collapse set the ecosystem back by
12 months. Throughout most of 2023, most capital markets participants (mainly
speculators) left Solana for dead. But the core ecosystem teams—including,
without limitation, Dialect, DFlow, Drift, Drip, Helium, Hivemapper,
Hubble/Kamino, Jito, Jupiter, Magic Eden, marginfi, Marinade, Metaplex, Orca,
Phoenix, Pyth, Raydium, Solend, Squads, Tensor, and TipLink—continued to build,
mostly under the radar.
By Breakpoint 2023, the ecosystem achieved enough momentum that some market
participants started to re-examine their priors about Solana, and very
importantly, started to play around with it. In our opinion, they were all
generally impressed, and started buying SOL and using Solana regularly.
Today, most DePIN projects rely on Solana. These projects include Hivemapper,
Helium, Render, io.net, Kuzco, Teleport, GEODNET, etc. Similarly, both private
companies, such as Stripe (link), and major Fortune 500 fintech companies, such
as Visa (link) and Paypal (link), have selected Solana as their venue (or one of
a few venues). Additionally, with the rollout of token extensions earlier this
year, Solana is now capturing meaningful RWA market share. In fact, Hamilton
Lane recently launched a credit fund on the Solana blockchain. The Solana
snowball is rolling downhill.
Solana’s success as of late can be seen in the uptick in usage relative to
Ethereum and other modular networks. User activity on Ethereum has been
decreasing relative to Solana, we believe both as a function of poor UX, high
latency, and high fees, as well as increased reliance on L2s (which cannibalize
ETH’s primary value capture mechanism, which is MEV).
Source: Artemis
Daily Active New Addresses on Solana meaningfully flipped Ethereum L1 on a
consistent basis over the last quarter, illustrating the user migration from
expensive transaction environments to Solana’s low-cost environment.
Source: Messari
In Q1 2024 we also saw Solana generate more MEV than Ethereum for the first
time, as evidenced in the chart below. This is significant because, until
recently, it was a widely held belief that Solana would never eclipse Ethereum’s
economic activity. However, over the last six months, Solana has routinely
flipped Ethereum.
Source: Blockworks Research
We expect the momentum for Solana to continue through the end of the year and
well into 2025, buoyed by the rollout of Firedancer and the annual Solana
developer conference Breakpoint, which is in Singapore in a few weeks.
Firedancer is a new validator client that is being built by Jump Trading, one of
the largest high frequency trading firms in the world. Jump Trading is building
Firedancer with networking speed and performance as the main focus, and they are
uniquely qualified to do so given their decades of experience building low
latency trading systems. Firedancer is expected to be much more performant than
the current Solana client and thus will materially help Solana DeFi protocols
and their users. Since Firedancer is written in a different language than the
existing Solana client, a single bug or glitch in either client should not
theoretically impact the entire network. Multiple network clients thus
dramatically increase Solana’s resiliency in addition to making it faster.
DRIFT TOKEN
DRIFT is the native token of Drift. Crypto investors, including us, have
(rightfully) been skeptical about certain DeFi tokens’ abilities to capture
value for a long time. Questions arise such as:
● Which entity, token holder group or lab co, actually earns revenues from the
protocol?
● Can a protocol’s token be forked out?
● Does the token suffer from the velocity problem?
● Does issuance from liquidity mining lead to wash trading, and is the protocol
incentivizing fake usage?
● Is there utility value that can be gained by using or holding the token?
We believe that DRIFT is a compelling asset that possesses many of the
attributes we’ve been talking about for years that encapsulate how a DeFi token
can become valuable under the right design and circumstances.
We previously introduced the “equation of exchange tokens,” a term we coined
while doing due diligence on Binance. It is as follows:
Exchange token network value = value created by exchange * efficiency of token
value capture
“Value created by exchange” is how the exchange business is performing on a
fundamental level. Examples include trading volume, daily/weekly/monthly users,
website traffic, trust, liquidity, ability of management to execute, etc. We
have highlighted Drift’s growth story in this essay above, and also their
opportunities to expand their business beyond “just another DeFi perps
exchange.”
The other part of the equation relates to the token itself. In examining
derivatives DEX tokens, we think the opportunity for value capture is clear. The
basic premise of our thesis is that some DeFi protocols have inherent risk
associated with them. Owners of these protocols’ native tokens are primarily
responsible for governing that risk and ensuring the protocol remains solvent.
They also take on the risk of being diluted or slashed in the event there is a
shortfall. For managing the system and taking on the risk of there being an
insolvency, those token holders must be compensated via fees from the protocol.
Drift enables a ton of leverage, and thus DRIFT token holders have a substantial
amount of risk to manage.
There are additional benefits that can also come from holding the DRIFT token.
These include fee discounts on trading, governance on choosing a risk council,
tiered increases for referrals, etc. The DRIFT token recently launched, and we
expect the community to quickly vote for these value capture mechanisms,
following in the footsteps of BNB and other exchange tokens before it.
DRIFT VALUATION FRAMEWORK
We assume for the purposes of our valuation model that 100% of revenues that
flow through the DRIFT protocol will accrue to token holders (the Drift team has
not implied any value will be captured at the front-end layer). Importantly,
100% of protocol revenues today are accrued to a token governed treasury pool.
Because Drift is governed by the community, we do not know precisely whether the
revenue will flow through via passive/active treasury management, direct
payouts, buy and burns, etc., but we expect within the next 1-2 years it will be
obvious one way or another.
DEXs—both derivatives and spot—are some of the best businesses on the planet
because they have margins that can almost approach ~95%. CEX margins are also
fantastic, but they have to pay for customer support, global licensure, servers,
big custody management systems, etc. Uniswap famously was doing 77% of
Coinbase’s volume during 2021, with 33x fewer employees. For our valuation
model, we ignore expenditures because the protocol is sustainable already, and
in the long state economic equilibrium we believe it will be a 90%+ margin
business.
For this valuation, we will use a cash flow multiple methodology. We assume that
Drift protocol revenue (which currently is entirely directed to the token
governed treasury) will be captured through some mechanism to the DRIFT token.
DEFI DERIVATIVES
DeFi derivatives market share is currently 4.9% of all crypto derivatives (per
The Block Pro and DefiLlama data). We predict that DeFi derivatives will achieve
10% market share by 2027, which we think is very reasonable, if not too
conservative.
We also project that the market for crypto derivatives broadly 2x’s in three
years’ time (which we also view as conservative). Today, the total market for
crypto derivatives is ~$48T annualized across CeFi and DeFi. In our model, that
would mean total crypto derivatives volumes are ~$96T annualized in 2027, and
DeFi derivatives volumes are $9.6T annualized (~4x August 2024’s annualized
realized volume). Note that none of this requires any sort of synthetic trading
of RWAs, as we project this growth can come only from native cryptoassets.
As U.S. markets are currently blocked by all major perps CEX and most
derivatives DEX front ends, one material area of potential growth that we are
not accounting for with precision is the U.S. user. DeFi regulation is uncertain
and will materially vary the potential TAM for U.S. and, to a slightly lesser
extent, E.U. markets. Current market size accounts for this lack of clarity, and
thus we assume zero U.S. market access for the foreseeable future in our model.
Absent material electoral changes in November, we do not expect to see broad,
permissive regulatory change (whereas change could stimulate far greater TAM
growth not accounted for in our model).
BORROW/LEND
DeFi borrow/lend borrow outstanding today is ~$11.77B (excluding $5B of DAI),
per Token Terminal and Solana DeFi websites. This has grown at 64% CAGR since
Aave's launch (higher if you extend farther back). We conservatively estimate
this will 2x by 2027, implying $23.54B of loans outstanding in DeFi.
Lending protocols monitored by Token Terminal generated $1.7M in revenue over
the past week, implying $88.4M of annualized revenue * 2x = $176.8M. At 5%
market share, this would be a ~$9M revenue line for Drift. They are currently
~55 bps in market share.
We do not include spot exchange in our valuation because Drift is a small player
currently, and we view the business line as call option value.
VALUATION MODEL
In order to derive our valuation model for DRIFT, we have established a
framework of key assumptions that we believe to be the base case2. In summary,
our base case assumptions are:
● Total crypto derivatives volume doubles in size by 2027.
○ CeFi derivatives volume grew at 63% CAGR between 2019 - 2024, per The Block
Pro data.
● DeFi derivatives will be 10% of the market for crypto derivatives by 2027, up
from 4.9% today.
○ DeFi’s market share in crypto derivatives has grown at 56% CAGR over the last
2 ½
years, per The Block Pro and DefiLlama data.
● Drift will capture 10% of the DeFi derivatives market by that time, up from
2.2% today.
○ Drift was at 0.22% market share in August 2023, per The Block, Top Ledger, and
DefiLlama.
● Drift is able to capture a 4 bps net take rate.
○ Actual August 2024 realized net take rate was 5.6 bps (conservative because we
include spot and swap volumes in the denominator, which are lower margin revenue
lines for Drift today), per Top Ledger.
In our valuation model, which explicitly assumes (1) modest market growth, and
(2) Drift capturing a higher percentage of DeFi activity based on a superior
product, we arrive at a plausible scenario in which the Drift protocol is
generating ~$392M of annualized revenue, or $0.3928 per token (as depicted in
the table below). This does not include more speculative revenue opportunities
such as Anatoly Yakovenko, Solana’s founder, recently claiming 75% of MEV will
be captured at the application layer.
For context, in August 2024, Drift generated ~$2.8M of revenue, or ~$33.5M on an
annualized basis. 12x revenue growth in three years, when the protocol 50x’d
volumes and 10x’d market share over the past 12 months, with substantial looming
Solana DeFi tailwinds, does not sound crazy to us.
We do not explicitly claim that DRIFT should be worth $X because of DeFi
borrow/lend or derivatives DEX token comps because there are several outliers
and crypto markets can remain irrational over short timeframes. However, as a
point of reference, we looked at relatively mature DeFi protocols and their
respective price to “sales”3 multiples (per Token Terminal data):
● AAVE trades at a 37x P/S multiple
● MKR trades at a 23x P/S multiple
● LDO trades at a 22x P/S multiple
We also examined the principal derivative DEX tokens (per DefiLlama and Token
Terminal data):
● DYDX trades at a 135x P/S multiple
● GMX trades at 14x P/S multiple
As a contrast, DRIFT currently trades at approximately 14x P/S. Given the
comparables, we think 25x as a base case revenue multiple is quite appropriate.
In the “bear” and “bull” case, we simply decrease/increase the price to sales
multiple, but do not adjust our underlying assumptions regarding the market and
Drift’s capture of market share.
● Bear case multiple of 10x = 0.3928 X 10 = $3.928
● Base case multiple of 25x = 0.3928 X 25 = $9.82
● Bull case multiple of 50x = 0.3928 X 50 = $19.64
We must then discount from 2027 to 2024. We apply a 40% annual discount to
capture the significant risks that Drift is able to take market share in the
DeFi derivatives market, and that the market grows. 40% discount rates are
considered appropriate for mid-stage business ventures (given DRIFT is a
publicly tradable asset, we believe the discount rate is fair). This implies a
discount factor of (1 + .4) ^ 3 = 2.744:
● Bear case: discounted value of $3.928 / 2.744 = $1.43
● Base case: discounted value of $9.82 / 2.744 = $3.58
● Bull case: discounted value of $19.64 / 2.744 = $7.16
The key assumption and driver is on the derivatives side. As a result, if Drift
does not capture substantial market share in borrow/lend or spot, we will not
expect a massive impact in the model.
We did our best to avoid “garbage in, garbage out” modeling as much as possible,
but there is bias in every model. We encourage the reader to go through this
exercise on their own time. If you would like to play with our assumptions, we
have attached a download-able spreadsheet that you can modify based on your
market assumptions and value drivers. Link here.
SUMMARY
Drift is going to be the Binance moment for derivatives DEXs. Market share has
come and gone in the DeFi derivatives space, much like it did for CEXs before
Binance came along, but we think Drift is going to emerge as the key winner in
this market.
We have conviction in this belief because Drift has designed the correct
derivatives DEX construction from first principles. We do not view appchain
derivatives DEXs to be the correct path long term and we expect market share to
eventually work its way over to Drift as traders come to appreciate the capital
efficiencies that Drift offers.
In the last 12 months, we believe the Solana ecosystem has provided
incontrovertible evidence that it is the most viable public blockchain that can
actually fulfill the primary vision of crypto: a permissionless, low-cost,
low-latency asset ledger for everyone in the world. Most people still have not
recognized this, even though the facts are there in plain sight. And further,
Drift is the most compelling derivatives DEX on Solana because of composability,
its three types of liquidity provisioning, its liquidity platform and path to be
a superapp, and the team’s dogged persistence in the face of adversity.
Drift’s north star is a generalized DeFi derivatives platform underpinned by a
liquidity layer that any derivative can be traded or cross margined on top of,
in a completely open, noncustodial, and permissionless way. We expect
hyper-localized, third-party front ends to emerge on top of Drift’s liquidity
layer all over the world. These customer-face applications will compete on user
acquisition, fiat on/offramp pricing, UX experiences catered towards specific
geographies, etc. — all while not having to build out smart contracts or
aggregate liquidity themselves.
Drift’s cumulative volume across perps, spot, and swaps is up ~50x year over
year, with most of the growth attributable to their core product: perps. Their
market share in DeFi derivatives increased ~10x over that same timeframe, but it
is still small with plenty of room to run. It is an extremely high margin
business, with clear future value capture look through for DRIFT token holders.
In summary, based on the assumptions laid out above and using our valuation
model, we think DRIFT is sharply undervalued at its current price of $0.46. Our
thesis is that Drift will continue to eat market share in a growing derivatives
DEX space, and that the protocol and token will compound as a result. Our base
case price target is $3.58.
IMPORTANT DISCLOSURES
Multicoin Capital Management LLC (“Multicoin”) provides investment advice to
certain private fund clients (the “Fund(s)”) that own DRIFT tokens discussed
herein and stands to gain in the event that the price of the token increases.
Multicoin is adopting a “No Trade Policy” for the Funds and for Multicoin’s
officers, directors, and employees, which restricts the purchase and sale of
DRIFT tokens for three days following the public release of this report (“No
Trade Period”). Following the No Trade Period, the Funds are free to buy or sell
DRIFT tokens (and Multicoin’s officers, directors, and employees may trade
subject to certain pre-clearance procedures). The DRIFT tokens held by the Funds
are marked for the Funds’ valuation purposes using Fair Market Value pursuant to
Multicoin’s Valuation Policy, which valuation methodology is accounting-based
and differs from the valuation methodology used in this report. The valuation
methodology used in this report is opinion based, provided solely for the
purposes of discussion, and should not be relied upon as the basis for
purchasing or selling DRIFT or any similar token and may differ materially from
the accounting-based valuation methodology used by the Funds. This report’s
estimated valuation only represents a best efforts estimate of the potential
valuation of DRIFT, and is not expressed as, or implied as, assessments of the
quality of a token, a summary of past performance, or an actionable investment
strategy for an investor.
Multicoin believes that the information provided herein is reliable as of the
date of publication, and makes no representations about the enduring accuracy of
the information or its appropriateness for a given situation. The information is
presented “as is,” without warranty of any kind – whether express or implied.
This post may contain links to third-party websites (“External Websites”). The
existence of any such link does not constitute an endorsement of such External
Websites, their content, or their operators. These links are provided solely as
a convenience to you and not as an endorsement by us of the content on such
External Websites. The content of such External Websites is developed and
provided by others and Multicoin takes no responsibility for any content
therein. Charts and graphs provided herein are for informational purposes solely
and should not be relied upon when making any investment decision. Any
projections, estimates, forecasts, targets, prospects, and/or opinions expressed
in this report are subject to change without notice and may differ or be
contrary to opinions expressed by others.
The content is provided for informational purposes only, and should not be
relied upon as the basis for an investment decision or for valuing tokens. The
contents herein are not to be construed as investment, legal, business, or tax
advice.You should consult your own advisors for those matters. References to any
securities or digital assets are for illustrative purposes only, and do not
constitute an investment recommendation or offer to provide investment advisory
services. Any investments or portfolio companies mentioned, referred to, or
described are not representative of all investments in vehicles managed by
Multicoin, and there can be no assurance that the investments will be profitable
or that other investments made in the future will have similar characteristics
or results. A list of investments made by funds managed by Multicoin is
available here:https://multicoin.capital/portfolio/. Excluded from this list are
investments that have not yet been announced (1) for strategic reasons (e.g.,
undisclosed positions in publicly traded digital assets) or (2) due to
coordination with the development team or issuer on the timing and nature of
public disclosure. This report does not constitute investment advice or an offer
to sell or a solicitation of an offer to purchase any limited partner interests
in any investment vehicle managed by Multicoin. An offer or solicitation of an
investment in any Multicoin investment vehicle will only be made pursuant to an
offering memorandum, limited partnership agreement and subscription documents,
and only the information in such documents should be relied upon when making a
decision to invest. Any investment involves substantial risks, including, but
not limited to, pricing volatility, inadequate liquidity, and the potential
complete loss of principal.
The information contained in this document may include, or incorporate by
reference, forward-looking statements, which would include any statements that
are not statements of historical fact. These forward-looking statements may turn
out to be wrong and can be affected by inaccurate assumptions or by known or
unknown risks, uncertainties and other factors, most of which are beyond
Multicoin’s control. When investing you should conduct independent due
diligence, with assistance from professional financial, legal and tax experts,
on all tokens discussed in this document and develop stand-alone judgment of the
relevant markets prior to making any investment decision. Past performance does
not guarantee future results.
