Intro to Cryptocurrency
The cryptocurrency revolution was kicked off by Satoshi Nakamoto’s invention of Bitcoin. It was during the height of the 2008 financial crisis that Bitcoin was born. Poetically, it included in it a message from Satoshi himself that read “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks”. Bitcoin was built as a stand against everything about Wall Street. Bitcoin was made to be the people’s money. 11 years later, it has grown to almost $300 Billion in market capitalization. One of the first Bitcoin transactions involved a guy paying 10,000 BTC for 2 pizzas. Today, with each Bitcoin worth over $9000, you can buy around 1,000 pizzas. That’s a 500,000,000% increase in value.
DeFi, which stands for decentralized Finance, is a recent movement within the cryptocurrency space. While Bitcoin could be considered a DeFi since it is a decentralized form of money, it does not have smart contract functionalities. DeFi is therefore defined as financial smart contracts that offer traditional financial services in a decentralized manner. This includes services such as wallets, lending, borrowing, exchanges and stablecoins. Majority of DeFi products and services are built on top of the Ethereum Network which is the leader in the field of smart contracts but there are also DeFi projects on other major blockchain platforms like EOS and TRON.
Problem with Legacy Finance
There are many flaws and problems with our current legacy financial services. These services are made to enrich the bankers themselves. Majority of the risk are given to the people while they get a lion’s share of the profits. And for the services that they offer the people, they only offer to those that have bank accounts. More than 30% of the global percentage of adults still do not have access to bank accounts especially in poorer countries. While this has already improved significantly over the past decade, there still is a long way to go to make financial services available to everyone. Another problem is that traditional banks tend to discriminate. Those with the most money are offered the best deals as well as the best services while those who are less fortunate get the short end of the stick. DeFi aims to solve this problem and can bring the final billion people of the global population into the new financial system.
Rise of Decentralized Finance
The Decentralized Finance (DeFi) promotes a global, open alternative to almost every financial service you use today. From savings, loans, trading to insurance there is a company building a product for it. These services are done in a decentralized manner. This makes it easily accessible to anyone in the world with a smartphone and an internet connection. Unlike every bank which offers every service, these companies often focus on one specific area and thus can provide the best possible service and offer it to a global audience.
Features of DeFi
DeFi brings the many aspects of cryptocurrencies to financial products.
Permissionless and Global – Anyone can participate in this global movement. They won’t need to be pre approved for any of these services. These services are made to be global from day one. As long as it makes sense for the market, it will be available. There is no discrimination even on geography. Whether you’re from Africa or from Europe, the service level will be the same. In fact, some of these services won’t even need to know these details.
Decentralized – As much as banks offer some of the best securities in the world, they are still prone to hacking especially in this digital world that we live in. The fact that there is one database out there makes it a point of vulnerability. Having a decentralized setup where nodes are spread all over the world and are financially incentivized to be honest keeps the entire network strong and secure.
Interoperable and Customizable – Different DeFi products can be mixed and matched together. New applications can be built by combining different products that are already available in the market. With most of these DeFi products offering API access, you can even create your own interface or automate it with a bot if you want to. It’s almost impossible to get the same amount of freedom from traditional finance.
Transparency – One of the hallmarks of cryptocurrencies is the amount of transparency that it brings. Transactions are available for everyone to be seen anonymously. As for hacks, as soon as an exploit is made, anyone will be able to see how it was done and quickly help patch it up. Unlike banks which are built on a shroud of secrets, DeFi can bring light to issues much faster and keep teams and projects more accountable.
DeFi Categories
While there are dozens of categories in the DeFi world, here are some of the most popular categories and the projects building in them.
Stablecoins – Stablecoins are cryptocurrencies that have a fixed equivalent in fiat. The most common example is the USD stablecoin. It is a cryptocurrency that has the same value as 1 USD. It offers the advantages of cryptocurrencies such as transparency and programmability while removing the volatility of other cryptocurrencies whose value could fluctuate 10 or 20% in a bat of an eye. Different projects have different ways of maintaining the peg of their stablecoin.
Fiat Backed – USDT (by Tether) and USDC (by Coinbase) are the most common examples of this. For every USDT or USDC coin they issue, they have an equivalent amount of dollars in their reserve. Although USDT is the most popular stablecoin, it is not held in a regularly audited bank account like USDC.
Crypto Collateral – MakerDAO issues a stablecoin called DAI which uses approved cryptocurrencies as a collateral instead of a fiat currency. Since cryptocurrency value fluctuates heavily, it requires overcollateralization.
Algorithmic Stablecoins – These are stablecoins that are not backed by any collateral. Instead, they rely on the economic forces of supply and demand to keep the peg to a fiat currency. For example, when a coin is supposed to be pegged to $1, and the price increases to $1.05, the circulating supply will increase so price will theoretically go down. Ampleforth is a working example of this. While it works in theory, practice has shown that rebalancing can take its time especially with the speculative nature of cryptocurrencies.
Lending and Borrowing (Money Markets) – Just like borrowing and lending money from banks, you can now do so with DeFi products such as Compound and earn or pay interest on those loans. It is a blockchain based money market that accepts several major cryptocurrencies as collateral each with their own rates based on market demand. When it comes to DeFi, Compound is the giant in the space. It has around $600 million worth of assets locked in it which accounts for more than ¼ of all assets locked in the DeFi space. Other popular lending and borrowing dapps are Aave ($LEND) and bZx ($BZRX).
Automated Exchanges – Uniswap and Kyber Network are examples of this new wave of decentralized exchanges that run on smart contracts. Uniswap uses an automated market maker (AMM) where price moves based on supply and demand and gets rid of the order book altogether. Kyberswap on the other hand is a permissionless cross-chain atomic swap enabling trading across different chains. Other popular decentralized exchanges include 0x, Balancer and Bancor.
Prediction Markets – Augur ($REP) is a decentralized oracle and peer-to-peer prediction market protocol. With Augur, you can create a market around the outcome of any real-world event and vote or bet on the outcome these events. Prediction market platforms like Augur harnesses the “wisdom of the crowd” and turns it into a financial tool.
DeFi Resources
The world of DeFi has taken a life of its own and has become the hottest sector in the cryptocurrency space. An index for top defi projects was created by FTX and has shown a 50% increase in its 1 month of existence. There are multiple websites online that can help you navigate and be updated in this field.
Defi Pulse is a great resource online that keeps track of both major DeFi projects as well as highlights new ones. You can easily filter and choose which subset of the DeFi sector you would like to explore. They also keep statistics on the amount of collateral locked in each platform.
Defi Prime is another website that collates DeFi resources from around the web. They regularly highlight different projects as well as events in the DeFi space. They also highlight DeFi projects from other blockchain platforms such as EOS and TRON.