These are frightening and uncertain times. COVID-19 infections are spreading and on the rise across the United States and the world. The outlook for the next coming months is uncertain as countries race to push out a vaccine for this coronavirus that has shaken global economies. As the world heads towards a recession, there is a new, parallel financial system that is emerging. DeFi – you may have heard this term being thrown around in the recent years due to its meteoric growth as a sector in the cryptocurrency industry.
DeFi or Decentralized Finance is a digital financial system that runs on top of a public, permissionless blockchain ledger: primarily Ethereum. DeFi takes existing financial products and services such as: lending, borrowing, trading, and more – and puts them all onto the blockchain, removing any need for any third-party central financial institution such as banks and even governments.
A couple of years ago, ICO’s were all the craze, now the hype is all on DeFi. This article will dive into the key fundamentals of decentralized finance, how it compares to traditional methods of finance, its applications in the future, as well a mention of some of our favorite decentralized applications that exist in the DeFi ecosystem.
Traditional Finance vs. Decentralized Finance
Key Products in Ethereum’s DeFi Ecosystem
Other Notable: Synthetix, Digix Gold, Dai, StableUnit, TrueUSD, Carbon, Reserve, Ampleforth, Terra
Stablecoins are blockchain-issued tokens that are designed to hold on its value – hence the ‘stable’. They are usually pegged 1-to-1 with fiat currencies such as the U.S. Dollar and incorporate collateral to accommodate for any price fluctuations or variations.
There are 3 different types of stablecoins:
Includes: TrueUSD, Gemini Dollar, Paxos Standard Token, Digix Gold, Stably, USD Coin
Fiat-Collateralized stablecoins are the most straight-forward type of stablecoin. These types of stablecoins are backed by fiat money or precious metals. Fiat-Collateralized stablecoins have value because it is a representation of a real-life asset.
Includes: Dai, Havven, Augmint, Sweetbridge
Crypto-Collateralized stablecoins are backed by digital assets that are on the blockchain. These types of stablecoins are backed by cryptocurrency assets, primarily Ethereum.
Includes: Basis, CarbonUSD, Kowala, Fragments
These types of stablecoins are collateralized with fiat or cryptocurrency assets. Instead, based on an algorithm, the system maintains a ‘stable’ price by supplying more tokens + lowering the price of tokens with increased demand in the network, and burning tokens + increasing price with decreased demand in the network.
Other Notable: Dharma, Celsius, Ripio Credit Network, InstaDApp, Lendroid, Lendoit, Cred, Colendi
Open Lending Protocols are digital currency lending platforms that are built on the blockchain. Open lending protocols have become increasingly popular in the DeFi space. It offers many advantages over traditional borrowing/lending services such as:
Instant transaction times + settlement
Collateralization of digital assets in the case of default
Automation in the smart contract process can reduce costs
No credit checks, giving broader banking access to people that do not have access to traditional banking services.
Other Notable: Eth2Dai, Centrifuge, Ethfinex, Paradex, Bancor, Ren, ForkDelta, Airswap, DEX.AG, Kyber Network
Decentralized Exchanges (DEXes) are one of the essential applications that exist in the DeFi ecosystem. DEXes are cryptocurrency exchanges that operate on a peer-to-peer trading system between two parties on the blockchain with no third parties involved whatsoever. A huge advantage to this approach of trading cryptocurrencies is that there is no registration involved or KYC required to start trading on a DEX. Additionally, decentralized exchanges typically have lower trading fees than centralized exchanges.
Other marketplace type applications in the DeFi marketplace involve the sale of non-fungible tokens (NFTs) or more commonly known as ‘crypto-collectibles.
Other DeFi Applications
Custodial Services: Wallet services. Be the keeper of your own coins!
Payments: Payments applications, protocols and solutions that are focused on creating an open financial ecosystem.
Insurance: Applications that provides insurance on the blockchain.
Prediction Markets: Exchange-traded markets that are created to trade the outcome of real-life world events.
KYC & Identity: Next-generation applications, protocols and frameworks for managing user data on the internet.
DeFi Companies To Keep An Eye On
yEarn is one project that has become all the rage in DeFi and the cryptocurrency ecosystem. The platform automates the complexities behind ‘yield farming’ and is controlled by holders of its native governance token, YFI. Governance tokens are tokens that allow the holders to vote on decisions on the network.
Yield Farming is an up-and-coming method for cryptocurrency users and holders to earn passive income. It involves receiving various incentive rewards for locking up/staking different cryptocurrency tokens into yield farming pools.
The MakerDAO project is all about generating stablecoins. MakerDAO are best known as the protocol behind the DAI stablecoin. MakerDAO offers all the advantages of digital currencies without the associated volatility due to advanced mechanisms in the protocol that maintain price stability.
MetaMask is an Ethereum wallet that allows its users to make Ethereum transactions directly from web browsers. MetaMask is one of the applications that is pushing cryptocurrencies to the masses, as it is implemented into regular web browsers with millions of daily active users.
Compound Finance has become one of the increasingly popular products in the DeFi space. The Compound Finance protocol enables decentralized peer-to-peer lending and borrowing for cryptocurrency assets. Borrowers loan digital assets directly from the protocol, and suppliers of the asset earn interest rates immediately.
Uniswap is a decentralized exchange that allows you to swap digital currencies for one another. Often times newer cryptocurrencies are only available on decentralized exchanges until listing on a centralized exchange. These cryptocurrency assets are often the riskiest investments but there have been some in the past known to generate immense returns for those with a high risk, high reward appetite.
We’ve gone through all the benefits of some of the key products in the DeFi space. However, DeFi doesn’t come without its own disadvantages:
Reliance on the security of smart contracts - susceptible to hacks.
Higher risk for user error without any third party intermediaries.
Cluttered ecosystem - a lot of products in the ecosystem can make it daunting for users to find the best protocol or platform for them.
Poor performance & user experience - Blockchain applications are still slower than their centralized counterparts. Developers need to make user experience seamless to entice mainstream, retail users, as well as develop and optimized applications to scale.
All Hype? Or Is DeFi Here To Stay?
Ever since the ICO craze of 2017 the cryptocurrency industry has not been able to disassociate itself from the word ‘bubble’. In recent months, the DeFi space has grown rapidly with many DeFi projects gaining momentum - seeing growths of over 1,000% in some cases. But is this all hype? Will all of this momentum die down eventually like it did with the ICO craze in 2017?
Weiss Crypto Ratings tends to believe the DeFi hype will die down:
‘#DeFi is one of the most exciting things going on in the #crypto right now, but the idea that this sector will decouple from the rest of the market is ludicrous. Eventually, the mania will end, and DeFi will trade in line with the rest of the market.’ - Weiss Crypto Ratings (Twitter)
By focusing on decentralized finance and building applications on top of that ecosystem, DeFi is building a whole new financial system that is separate from the traditional financial system. The decentralized aspect of DeFi opens up the possibilities for individuals in the current financial system, creating a system with more freedom and less censorship.
It is important to consider the fact that not every industry or business can benefit from blockchain technology. We must be able to differentiate the benefits and disadvantages of blockchain technology in various industries and evaluate which industries can best strive from this future technology. Ultimately, if successful, DeFi will be the catalyst for a power transfer from financial institutions to the open-source community and individual. It’s too early to tell, but if DeFi has what it takes to reach mainstream adoption, it could be the answer for a more efficient financial future. The DeFi hype may last a while, it will probably eventually cool down. But, its foundation as a new financial structure may just be around to stay.