ARS Element Finance featured image

DESCRIPTION OF BUSINESS

EXECUTIVE SUMMARY

Decentralized Finance (DeFi) is a fast-growing market segment. Total Value Locked (TVL) in DeFi, the most followed market metric, reached a level as high as $195 billion in relatively early stages. From basic protocols (such as lending/borrowing products) to more complexly structured DeFi projects, many innovative ideas entered the market as a natural result of an active community. The lucrative opportunities created by the DeFi market have attracted significant institutional interest and prompted a trend of institutional capital flow into DeFi.

Against this backdrop, Element Finance saw an underserved niche within the broader yield markets. When a DeFi user establishes a yield position, such as locking capital in a Yearn vault or an ETH2.0 validator, they cannot access further market opportunities. Element Finance offers the same high yield opportunities with the added value of capital efficiency, market liquidity, and reduced use costs.

At its core, the Element Protocol splits base asset positions into two different fungible tokens, namely Principal Tokens (PT) and Yield Tokens (YT). Element is harnessing the composability of Ethereum and its team’s deep expertise in the ecosystem. The team’s product-first approach has already allowed them to accrue the highest amount of TVL amongst its closest competitors.

Element is an experienced team of blockchain and FinTech practitioners. The team is growing with additional resources supplied to it.

Element Finance aims to become an open, autonomous, community-governed protocol.

Our researchers gave Element Finance a final rating of 55.30%. (Note: Element Finance has not announced a native token as yet. Therefore, the final rating does not assign a rating for Tokenomics) The breakdown of this rating is available at the end of this report.

PRODUCT & COMPANY DESCRIPTION

Element Finance is an open-source protocol that makes it possible to pursue high fixed yield income in the DeFi market. In a nutshell, Element is a yield tokenization platform where the protocol (Ethereum-based smart contracts) splits yield-generating assets into two components: an interest component and a principal component. The two main products on Element Finance protocol are Earning and Saving. Element’s key benefit to its users is that they can acquire cryptocurrencies at a discount without being locked for a fixed term. Element also allows easy swapping between the discounted asset and any other base asset at any time. Additionally, Element offers a treasury diversification solution to Protocols, DAOs, and organizations looking to earn fixed-rate yields on treasury capital. Lastly, Element Finance SDK provides developers with an opportunity to interact and build on Element Smart Contracts.

Element’s goal is to “enable financial freedom and provide open access to financial products for people all around the world.”

The Core of Element Finance

The Core of Element Finance. Source: Element Finance Docs Portal

 

We identify the following as possible benefits by Element Finance:

  • Element provides an opportunity for both passive (risk-averse) and active (risk-takers) fixed-income market participants to reach better trade-offs.
  • Element supplies fixed-interest income holders with benefits from liquidity.
  • An opportunity to boost interest earnings by staking Principal tokens on an Automated Market Maker (AMM).
  • Possibility to use Element protocol to build other tools (structured products) to offer capital efficiencies to users.

Users in both variable and fixed yield markets face different trade-offs. In the current market status quo, users face issues like the need to move funds regularly to achieve a desired APY, higher transaction costs, lower yields in fixed-rate markets, low liquidity, impermanent losses, and slippage. Element Finance is trying to address these issues by creating a better product for the yield markets in DeFi.

Element tokenizes yields by splitting the principal component (the “base” asset) from a yield-generating position into two separate fungible tokens, namely the Principal Token (PT) and the Yield Token (YT). Once split, the user can now sell PTs at a discount (this market could enable a yield curve approach similar to traditional fixed income markets). Or, additionally, the user could provide liquidity to earn an additional fee or yield. Ultimately, both cases offer capital efficiency and liquidity to DeFi users.

In our view, staking liquidity platforms are offering a competitive solution to Element Finance. For example, StakeWise tokenized-staking product mints Deposit Tokens and Reward Tokens for every ETH a user deposits.

Element Finance has an excellent product-market fit according to our analysis.

The DeFi market is fast-growing and is a larger market within the broader crypto industry. Although dominated by Ethereum, for the most part, recently there has been a growing competition between Layer-1 blockchains to gain DeFi market share (e.g., Avalanche, Solana, Terra). There has also been an increased demand for opportunities in the DeFi space by institutions. DeFi offers a world of yield-generation methods, often measured in terms of Annual Percentage Yields (APY). However, there are few ways to hedge interest rate volatility and exploit interest rate movements for profit within these systems.

Interest rates are volatile

Interest rates are volatile. Source: DeFi Pulse

 

Element Finance has shown a healthy trend of Total Value Locked (TVL) growth in its protocol. Element’s current product iteration has only offered Yearn Vaults and certain crucial features (e.g., Yield Token Compounding, a real-time calculator). There can be future iterations with enhanced product offerings for this kind of feature. For example, developers could build features like Yield Ladder, de-collateralization, Simple Arbitrage bots, etc. One clear distinction between Element and other platforms is its organic growth. This growth was not a result of any incentivization program.

TVL in Element Finance (as of 04 October 2021)

TVL in Element Finance (as of 04 October 2021). Source: DeFi Pulse

 

Element Protocol is now officially deployed to Ethereum’s Mainnet. Users can connect their wallets to the Element platform and experience yield opportunities. There’s approximately $132 million in TVL in Element Finance (as at 4 October 2021).

Element Finance Platform.

Element Finance Platform.

 

There is also a repository containing Element’s open-source codebase.

Element Finance has published a Construction Paper, which doesn’t yet have a final version and will be updated over time. The report is comprehensive and includes an introduction, glossary definitions, an appendix, and a technical discussion of tokens and minting. Besides this paper, there is also an Element Finance Documentation Portal. It contains a FAQ, a glossary, a section on the platform’s core concepts, and security audit reports.

There were no patents registered under Element Finance. Filing for patents would be against their intention to be an open-source protocol.

The Element Finance GitBook documentation portal and Construction Paper explain the project idea in great detail. We understand that the project’s team has written the documentation so that a non-technical person can understand it. Element’s Medium blog is regularly updated about the protocol’s latest developments.

The Project is open-source. The codebase of the Project is hosted on GitHub. The Element Finance GitHub carries 14 repositories.

It also explicitly mentions that the products and code of Element are open-source and enable third parties to integrate or build on top of the platform. The Construction Paper has a dedicated section to discuss building on top of the Element Protocol and explores several ideas (e.g., Yield Ladders, Principal Protected Products, Ethereum 2.0, and principal tokens as collateral for borrowing) that could be built using ELF SDK. The SDK is a work in progress, still. The project team regularly invites (via their Community Calls) new developers to participate in building on top of Element.

As happens with most projects, the initial development work for Element is currently highly centralized and handled by the core project team.

SUCCESS FACTORS

Our research identified the below to be Element’s possible success factors:

  • Experienced and capable team.
  • Backed by a strong group of institutional investors as well as experienced pioneers in blockchain.
  • Operating in a relatively underserved niche in the broader DeFi yield market.
  • The product has achieved satisfactory market fit in a short span of time.
  • Strong partnerships.

MARKET CONDITIONS AND COMPETITION

Market Conditions

The DeFi ecosystem continues to grow in stealth. The Total Value Locked (TVL) in DeFi protocols, one of the most important indicators for assessing the overall growth rate of DeFi, reached ~195 billion as of 04 October 2021. Recently, there has been a trend for Layer-1 blockchains attempting to capture a share of the DeFi market in terms of TVL. For example, we note that Avalanche has reached ~$3 billion in TVL, Solana hit $10 billion, and Terra registered ~ $8 billion in TVL recently. The year-to-date return of the DeFi sub-sector as of the end of August 2021 shows an impressive 704% increase.

Total DeFi Total Value Locked

Total DeFi TVL. Source: DeFi Lama

 

We also witness the inflow of institutional capital into the DeFi space to provide access for institutions to a fast-growing DeFi market. Most recently, Bitwise Asset Management launched two single-asset DeFi funds, namely the Bitwise Uniswap Fund and the Bitwise AAVE Fund. At the beginning of the year, Bitwise launched Bitwise DeFi Crypto Index Fund. The Grayscale DeFi Fund currently exhibits Assets under Management (AuM) of $11.9 million. The recent Institutional Investor Digital Assets Study by Fidelity Digital Assets shows that 15% of investors considered yield opportunities as the most appealing factor to them. In comparison, 13% of investors viewed DeFi participation as attractive.

Appeal of Digital Assets (US, Europe and Asia).

Appeal of Digital Assets (US, Europe and Asia). Source: Fidelity Digital Assets

 

The market for DAO treasury management also sees early signs of growth. As per data provided by DeepDAO, the total AuM of the DAO ecosystem currently stands at ~$8.1 billion, spread across 145 organizations and 164 DAOs.

Competition

Element’s direct competition is in the niche market segment of Yield Tokenization within the broader yield market. There are already several different players competing in this segment.

Yield Tokenization Protocols

 

In addition to above mentioned direct competition, Element is faced with indirect competition from several different yield market protocols. These protocols offer structured products, zero-coupon loans and fixed rate lending. Alchemix, Horizon, BarnBridge, Saffron, 88mph, Notional, Yield, Hifi, UMA are some of these protocols.

How is the project different from its competitors?

We do not observe significant differentiation in Element’s offering. Besides, some of the competitors that we identify are still at very early stages.

That said, we note several subtle differentiations that set Element apart. Such differentiating factors in our view are:

  • Real-time calculator: Element claims that they offer a transaction simulation mechanism to emulate transactions before execution.
  • The Yield Token Compounding function.
  • A product-oriented focus (Better UI/UX).
  • A better developer ecosystem and ability to build on top of Element (e.g., One-Click solutions, Yield Ladder, De-collateralization, Simple Arbitrage Bots).

TECHNOLOGY REVIEW

Product

The Element Protocol, at its core, works by enabling users (via Ethereum contracts) to split the base asset (ETH, BTC, USDC, DAI) of yield generating positions, such as a Yearn vault or an ETH2 validator, into two separate, fungible tokens: a Principal Token (PT), and a Yield Token (YT). These Principal Tokens can provide a variety of utilities to different types of users.

Element’s Minting Process.

Element’s Minting Process. Source: Element Finance

Blockchain

Element has chosen Ethereum as their preferred network. In terms of smart-contract platforms, Ethereum currently leads the pack. In that regard, the platform selection is appropriate for Element’s purposes. Nonetheless, Ethereum currently faces several fundamental issues. Scalability and high transaction costs are some of the main concerns, which the Ethereum community is constantly working on overcoming.

While scalability is a huge concern for Ethereum and, therefore, to any protocol based on Ethereum, there have been efforts to overcome the problem. At present, most scalability solutions are dominated by Layer-2 solutions—for example, sidechains, rollups, and state channels. Ethereum’s response has been the move to Ethereum 2.0 with blockchain sharding.

Element is currently not utilizing any Layer-2 solutions. In the future, should the necessity arise, the project might have to integrate with such solutions.

Two security audits have been performed on the Element Protocol’s core contracts by Runtime Verification and PeckShield.

The Runtime Verification audit was focused on reviewing the functional correctness and integration with external contracts. The audit identified several issues in Element Finance’s core contracts which were either patched or fixed later. Overall, the audit found that the code was well written and thoughtfully designed, following best practices. Runtime Verification audit report can be accessed here.

Similarly, the PeckShield audit found several weaknesses, which Element Finance resolved. PeckShield also noted that Element Finance’s smart contracts are well-designed and engineered. The PeckShield audit report can be accessed here.

Element Finance is a yield tokenization protocol based on Ethereum’s smart contracts. Hence, blockchain technology is essential for the project. Therefore, essentially, the project relies on Ethereum’s consensus and security mechanism.

ROADMAP

There is no detailed and time-bound roadmap available for the project. The communication strategy of the project has been to communicate the project’s plans via Medium posts.

The team’s focus has been on three key milestones:

  • The road to Mainnet: The team has already completed these tasks.
  • Security roadmap: The auditors have completed the central security audits. However, there is an ongoing bug bounty on Immunefi.
  • Governance model and vision: The team has designed a governance framework to facilitate the future direction of Element with community participation. This milestone is yet to be achieved.

TEAM

The team has more than three decades of cumulative tech experience, especially in Blockchain and Fintech. Team members have founded other successful tech startups and handled diverse management roles before this project. One strength that the team possesses is its network of relationships in the Ethereum ecosystem. Their experience in the Ethereum ecosystem is a distinct advantage in our view.

Before launching Element Finance, some of the companies and projects that the team members were involved in were ConsenSys, Bounties Network, MakerDAO, Core contributors to Ethereum, Polymath, 0xLabs Authio, Venmo, PayPal, and DeFi Pulse.

Will Villanueva, the CEO, was a founding researcher for the Quilt (ETH2.0) team with ConsenSys. In the past, he co-founded and functioned as the CTO for ProcureNow and Bounties Network. He also has led tech teams at 6sense. He obtained his MS from the New Mexico Institute of Mining and Technology.

Jonny Rhea, Co-founder, and CTO spent most of his career with Bell Helicopter in different capacities. Later, he joined USAA as the Lead Data Scientist before joining ConsenSys as a Lead Protocol Engineer. Jonny obtained his BS in Mathematics and Computer Science and MS in Operations Research.

Charles St.Louis, COO, was involved in the MakerDAO project as a Decentralized Governance Architect before joining Element Finance. He was also a Core Contributor to Ethereum. Charles co-founded a healthcare-related blockchain project back in 2017. He’s a graduate of Queen’s University, Canada.

Windra Thio heads Strategy and Growth at Element Finance. Thio functioned as the MD/Research and Investment Analyst at Next Ventures and as the Chief Editor for The Tokenist before that.

Sarah Mackey joined Element in June as the Solidity Engineer. Before taking this role, she was a Software Engineer at Venmo. Sarah had a short stint with PayPal as a Software Engineer and was an academic assistant before that.

Advisors

Element Finance lists seven advisors to the project. These advisors are well-known in the Ethereum ecosystem and the community. The Advisors have copious amounts of experience in Blockchain technology that could come in handy for the project.

Fernando Martinelli is the Founder and CEO of Balancer Labs. He co-authored the Balancer Finance whitepaper. Balancer is very popular in the industry. Fernando also participated in the Seed funding round of Element Finance.

Mariano Conti is an investor and advisor to Ethereum, Defi, and NFT projects. He also took part in Element Finance’s seed round.

Joseph Delong is the CTO of SushiSwap.

General Comments on the Team & Advisors

The group of advisors is a prominent and active group of participants in the more expansive Ethereum space. In our view, the advisors have very relevant experience and exposure to meaningfully advise the project. Most of them possess investment experience as Angel investors. We believe that the advisors can make introductions to other resources in case the project team needs it.

There are no known controversial projects that any member of the team has previously worked on.

Public information suggests that most of the team is based in the USA, and almost all the staff has an engineering background. Therefore, it is fair to say that the company is predominantly product-focused and will need more headcount in sales, marketing, and partnerships to grow in the future, particularly outside of the USA. Interestingly, the project is already hiring for the below open positions.

  • Brand Designer.
  • UI Engineer.
  • Principal Economist.
  • Quantitative Finance R&D Engineer.

Social media channels like Twitter and Discord are provided for the public to reach the team. Out of them, Discord is the best channel to contact the management team.

LEGAL AND COMPLIANCE SPECIFICS

Jurisdiction

The project is registered as Element Finance, Inc., a USA-based company, with a certified mailing address at 8528 Davis Blvd, #134-262, North Richland Hills, Texas. Regarding any legal matters, users could reach the Company via the email address [email protected]

The USA is one of the leading blockchain-friendly jurisdictions in the world.

Different states in the US, however, have different treatments regarding crypto. States like Miami, Wyoming are considered very crypto-friendly, while others are not. Owing to strict investor protection rules and regulatory impediments, several projects have restricted US investor participation in public sale events.

The company has not obtained any specific operating license, financial license, or permits. Element is not registered or licensed by the CFTC, SEC, the Financial Crimes Enforcement Network, or any financial regulatory authority.

The platform and its Services are governed by the most recent version of the open-source license GPL-3.0 License.

Protocol Decentralization

As discussed in blog posts, Element has been designed to be an open, self-sustaining, community-governed protocol. The team commits to the principles of decentralization.

The Element Protocol governance model leverages:

  • Vote delegation (i.e., a refined form of representative democracy).
  • Capital-efficient voting (introduced a novel concept called “Voting Vaults”).
  • A community entrusted Governance Steering Council (GSC).

The Element Protocol Governance System is a set of smart contracts. The community will eventually govern the protocol. However, at this stage, the project has not announced a native governance token.

Partnerships

There are no publicly announced legal agreements by Element Finance. Nonetheless, we highlight the below partnerships.

Risk Harbor: Risk Harbor, a risk management marketplace for decentralized finance (DeFi), recently announced its support for the USDC vault on Element Finance. This partnership will allow Risk Harbor users to purchase protection for the USDC vault on Element Finance.

Antimatter: Antimatter announced an integration with Element Finance to connect its Perpetual Options deploying underlying stablecoins & their DAO governance treasury into Element’s fixed yield vaults.

Treasury management partnerships: A couple more partners joined Element to benefit from their treasury management solution. Drift Labs has diversified part of their stablecoin treasury into Element’s fixed yield USDC vaults. Similarly, Opolis deployed a portion of their treasury into their vaults.

Element Finance successfully raised a Seed funding round led by Andreessen Horowitz and Placeholder for $4.4 million.

Legal Advisors

The project does not have any publicly announced legal advisors.

Nonetheless, going by the website’s terms of use and Privacy Policy, we could reasonably assume that the project’s company has retained professional legal resources. The Terms of Use and Privacy Policy provide clear contacts and guidance to follow in any matters relating to legal aspects.

KYC & AML

Like most DeFi protocols, anyone could interact with Element Finance without performing any KYC/AML checks.

The project’s website carries detailed and specific Terms of Service and a Privacy Policy.  However, the website does not give reference to GDPR matters.

Token Classification

There is no token issuance by Element Finance at present. Future issuance of an Element Governance Token is a possibility.

Legal/Compliance Risks

Given that Element Finance has not conducted a token sale, the likelihood of the project encountering legal risks related to the issuance of unregistered securities is, at the time of publishing, very low.

However, there have been instances in the recent past that the Securities and Exchange Commission of the USA (SEC) investigating popular DeFi project developers. Although the platform did not suffer any significant threats in this particular instance, we note that incidents like this make industry headlines (reputational risk rather than Legal/Compliance risk). Achieving a considerable level of decentralization might be a solution to address any hurdles faced due to centralized control (noting that the regulatory environment is evolving).

SOCIAL MEDIA AND VIRALITY

Element Finance currently has ~12.5K Twitter followers. In comparison to its closest competitors, Element Finance’s Twitter presence is the most active in terms of the number of followers and activity.

Element Finance only maintains a Telegram announcement channel which currently has about 2.3k subscribers. Public discussion is allowed on the project’s Discord channel. The Discord channel currently has a little over 4.1k users, indicating that its social media presence is still rather small.

Element Finance has 140 followers on LinkedIn, a very minimal presence. Nevertheless, the account is relatively active (regular posts). There is no Facebook presence.

Element Finance has a limited presence on YouTube. The Project has its channel, which started two months ago and has four videos, with the most-viewed video having 648 views (as of writing). A few other crypto influencers and media outlets have mentioned Element Finance. The most popular YouTube video only has 4.4k views, so it is fair to say that it still has a minimal following.

Some of the notable mentions include;

We did not find sources to suggest that advisors are visibly promoting the project. The advisors to Element have significant social media followings, mainly on Twitter.

Element Finance’s Bug Bounty programs are centered around security, one of the most crucial parts of any DeFi project. There is an ongoing bounty program on Immunefi with a maximum bounty of $100k. The rewards of the bounty program are dependent on the level of the threats identified.

Risks to the Project

The following are our researchers’ identified risks:

  • Protocol/Platform risk: Element’s protocol relies on lending protocols or vault protocols like Yearn and Balancer, and hence Element’s risk profile is mainly dependent on risks within these protocols. Element has no control over these third-party protocols. Moreover, Element Finance is also subject to any drawbacks of the Ethereum blockchain (e.g., high transactions cost).
  • Pricing difficulties of derivative products: Complex contracts involve higher computation costs. Furthermore, there is no evaluation of any downside risks attached to any of the discussed use cases. In this event, this could cause results to differ from demonstrated outcomes, with a possibility of users incurring losses.
  • Principal and Yield Token liquidity: An efficient and deep secondary market to PT and YT is essential to attract investors.

RATINGS

Everything you see in this report is the aggregate result of an extensive research process carried out by a distributed team of researchers and crypto enthusiasts around the world. The process consists of 60 questions divided into three phases. Researchers are called to answer these questions about a project, while providing links or screenshots as evidence to support their answers. For every answer, they also provide a rating from zero to ten. The average of their ratings is detailed below.

Our researchers gave Element Finance a final rating of 55.30%.

ARS Element Finance final rating

DISCLAIMER

This Report is for informational purposes only and/or all or any of its content thereof, should not, may not and will not be taken to constitute, either as a whole or in part, any investment advice or recommendation or similar, regulated, or authorized advice, and D-Core by producing, disseminating, giving away, or making available this Report does not, should not, may not and will not be taken to advise on investments, or carry out any similar activity, or any regulated activity or any other authorized activity. D-Core is not authorized by the Financial Conduct Authority or by any other competent EU or elsewhere or otherwise competent authority to carry out any regulated activities and/or any activities within the scope of these authorities’ competence.

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