Decentralized Finance (DeFi) is the movement that leverages decentralized networks to transform old financial products into trustless and transparent protocols that run without intermediaries.
A new trend in the crypto industry, which covers the headlines of the media, including traditional — DeFi projects. Decentralized finance is already being called the new ICO, not in terms of realization, but in terms of huge growth in popularity of the direction. What is DeFi? A new boom in projects or the development of a new decentralized financial system? Let’s look further.
DeFi or Decentralized Finance- is a financial system based on blockchain and smart contracts, whose idea is to create a stable and transparent financial structure. The new financial segment in the crypto industry includes several activities:
1. Bail bonds for cryptocurrency. Anyone who has the right crypto currency in their wallet (mainly BTC, ETH, BAT, 0x, stablecoins and tokens on the Ethereum blockchain) can take a loan against digital assets. The amount of a credit depends on the amount of crypto currency the client wants to pledge: usually up to 50% of the value of the crypto assets is given, but there are services that are willing to offer even 75%, but this is not recommended. In cryptocredit, as in the crypto market, there is such a thing as a margin requirement — if the amount of the pledged asset is less than the amount of the loan, then your cryptocurrency will be transferred to the service. For example, you have left BTC as a deposit when it was priced at $10,000, you have taken $7,500 in fiat money. If the bitcoin value drops below $7,500 during the loan repayment period, you lose your funds. The percentage rate for these loans ranges from 8% to 16%.
2. Platforms providing trading with crypto-derivatives and tokenized assets. Futures and options- are decentralised finance because trading is not physically affected by the crypto currency. Tokenized assets are security-token, which is secured by a real asset. These may be stocks of companies, commodities, fiat currencies.
3. Native tokens of DeFi-platforms. As an example, let’s take the overdraft platform Nexo, which has an internal token of the same-name. When purchasing this token, the holder will receive quarterly dividends. The cost of the token is only $ 0.15, and according to the company’s management, 30% of the net profit of the platform is spent on dividends. In March 2019, the company’s net profit amounted to $3 mn, i.e. $900,000 was spent on dividends from this amount only.
4. Deposit. Any crypto currency holder can deposit their funds into a deposit account at an interest rate that differs beneficially from the traditional banks — up to 14% per annum.
In addition to the main four directions in the DeFI-segment, you can find services that provide opportunity to participate in various lotteries, crypto currency wallets with new features, not custodial exchanges. However, there are not many projects of this type and there is not enough information about them, so it is impossible to refer them to the general list of the companies in the sector.
DeFi services have become widespread due to their usage simplicity: a person should have crypto money, a phone and Internet access. If these conditions are met, anyone can become a client of DeFi-platforms.
Compared to the traditional financial and credit systems, decentralized finance has several advantages:
1. Lack of control from government regulators.
2. Fast and cheap transactions.
3. Low requirements for clients of DeFi platforms.
Let’s go more over the details on the last point . DeFi platform representatives do not care about your credit history, employment, religion, financial situation, etc. If a client has a relevant crypto currency, they are ready to provide a loan against bail, on very good terms. In fact, DeFi platforms are similar to microfinance institutions and pawnshops in everyday life. The policy is approximately the same: mortgage and get your money back. The difference, is that pawnshops and microfinance institutions charge the same interest per day, as DeFi platforms do per year. However, the service maintains its own lender rating and if you have stopped repaying your loan once, it will be quite difficult to take it again.
Another obvious advantage- is the lack of a clearly defined credit direction. In fact — interest rates on different services and platforms may be different, making it possible to find acceptable terms.
Active development of DeFi-platforms started after the second half of 2019. At that time, there were many services providing credits and loans secured by crypto currency. Well-known companies and individuals in the crypto industry have invested in start-ups from the DeFi-segment, specifically:
1. Vitalik Buterin and Fred Ehrsam (co-founder of Coinbase) invested in the Uniswap Ethereum platform.
2. Hedge fund Paradigm first became an investor for the MarketDAO platform, and then invested $25 million in the Compound startup.
3. The decentralized lending platform Dharma Labs received $7 million in investments from Coinbase Ventures, Polychain Capital, Y Combinator and Passport Capital.
4. Coinbase is also one of the investors in the Compound startup. The companies have entered into a partnership, after which the market announced that for those who hold deposits to Compound in the UDSC’s stablecoin, will be charged an additional 1.25%.
This is not a full investment list in DeFi-segment companies, but it already makes it clear that the community believes in further development of the industry. Since the beginning of 2020, more and more news related to decentralized finance has appeared in the news feed. Unfortunately, they are not always positive. Due to the initial stage of the sector development, various DeFi platforms are facing problems on their way. Let’s look at it in more detail:
1. In the period from 16 to 18 of February 2020, attackers removed $645 thousand from bZx platform due to an error in the source code.
2. On April 19, 2020 $25 million was stolen from the decentralized DForce protocol due to successful hacker attack. However, on April 28, 2020, the hacker returned funds. His own mistake contributed to this: 1inch.exchange, where he was running the stolen crypto currency, passed on his IP address to Singapore authorities. With this kind of gesture, he wanted to solve the problem and to avoid prosecution.
3. On June 29, 2020, $500 thousand was stolen from the Balancer DeFi protocol, using a vulnerability in a smart contract.
For the crypto currency market, decentralized finance acts as a popularizer: considering the growth of the DeFi-segment over the last year, it is likely that crypto currencies and tokens, which will be taken as collateral for credit, will become more expensive, due to the greater functionality of coins.
Furthermore, cryptocurrency crediting is used to hedge risks. Let us consider an example: you have a BTC that trades at $9,000. You assume that in a month it may become twice cheaper, but you don’t know it exactly. You contact the service to provide credits against the crypto currency, then leave your BTC and take $4 500. If your forecast turns out incorrect, you just pay the interest on the loan and take your BTC. If the forecast is correct, you are likely to lose significantly less, because in moments of high volatility it is not so easy to sell the asset at the right value.
Such a scenario occurred on March 12, 2020: at the moment when the BTC price went down to $3,800, a lot of deposits on various DeFi- services were taken over by companies, because the cost of the main crypto currency and altcoins went down by more than 50%. This couldn’t have an impact on the segment in general. In April 2020, the number of DeFi- services users and their popularity fell by half. However, by June of the same year, the total capitalization of the decentralized finance sector exceeded $5 billion, whereas in February it was estimated at $3 billion.
Famous projects in the sector
Compound — is a DeFI protocol that provides access to crypto currency loans. This protocol was created by Compound Labs, in 2018. For two investment rounds, the company managed to attract $33.2 million. The following crypto currencies can be left as collateral: ETH, BAT, DAI, ZRX, USDC, REP. The coin number, appropriate for bail, will increase in the future.
For two years of Compound work, it managed to overtake the leader of the sector — MakerDAO, which held a leading position almost since its inception. The policy of distribution of internal COMP tokens contributed to such a success. Possibility of voting for the further development of the project, under conditions of availability of internal tokens — the idea is not new, as MakerDAO has long realized. However, Compound went further and began to give out COMP tokens to all users of the service. This became a success of the company, which allowed Compound to take first place in the ratings of DeFI-services.
-Capitalization — $474 million.
-The token cost is $185.
-Blocked funds — $1.38 billion.
Balancer- is an automated market-making protocol. There is not much information about the platform on the Internet, as it’s quite new, but has already managed to take a leading position among DeFi projects. Balancer is a creator of pools, which provide liquidity. If you have crypto assets, you can place them in a pool that provides liquidity for the market. You will receive a percentage (which is not specified).
The interesting thing about this project, is that it is a competitor to other DeFi platforms and cryptocurrency exchanges. Projects such as Compound and Aave, provide the opportunity to open a deposit and to receive interest, and here to become a liquidity provider and to receive rewards. Balancer is dangerous for exchanges, because its clients act on the back side of the exchange, i.e. they provide funds for exchange. In the future, Balancer and similar projects may force traditional exchanges out of the market for lack of necessity.
- The capitalization is $67 million.
- The cost of the token is $10.67.
- Blocked funds — $225 mln.
MakerDAO — is a decentralized credit platform on the Ethereum Blockchain, that supports Dai, a stablecoine pegged to the US dollar. Anyone can use Maker to open a storage facility, to block a deposit such as ETH or BAT, and to generate Dai as debt against that deposit. Dai’s debt carries a stability fee (i.e. continuous interest), which is paid when the borrowed Dai is repaid. The platform was created in 2016.
Maker has held a leading position in the DeFi segment for quite long time, due to the lack of sound competition. However, with the appearance of such companies as Compound and Synthetix, it began to give up positions. Also, this was facilitated by an incident within the ecosystem, which will be discussing later.
- The capitalization is $458mn.
- The token cost is $455.
- Blocked funds — $1.2 billion.
Aave- is an open source protocol, which is not related to the storage of Ethereum for decentralized lending and borrowing. For lenders it uses the mints ERC20-compliant aTokens protocol in a 1:1 ratio to the supplied assets. Interest immediately begins to rise constantly, which is reflected in a constant increase in the number of LEND internal tokens, held by the lender. The project was launched in November 2017 as a P2P credit project by ETHLend. But there was a rebranding in 2018 at Aave, platform supporting 16 crypto assets, of which 13 can be used as collateral.
Aave offers flash loans: fail-safe, non-collateralized loans where borrowing and repayment must occur in the same transaction. Focused on developers, this feature can lead to innovative use of DeFi. The only charges are — 0.25% of the loans issued and 0.09% of the flash loans. The funds received are used to burn loans, reward lenders and compensate affiliates.
- Capitalization is $253 million.
- The token cost — $0.19.
- Blocked funds — $175 mln.
Synthetix — is a decentralized platform on the Ethereum blockchain, for the creation of tokenized assets: synthetic assets that track the value of the real assets. The project was launched in 2018 and originally planned to synthesize only fiat currencies, but there was a rebranding in February 2019. By March 2020, Synthetix supports more than 30 tokenized assets, which include fiat currencies, commodities (e.g. gold) and crypto currencies. The company plans to issue shares, indices and other derivatives.
To rise among various services, the project has benefited from cooperation with ChainLink — a service of oracle, that provides information for smart contracts without any need to trust a third party.
- The capitalization is $237 million.
- The token cost — $2.74.
- Blocked funds — $368 million.
Is everything that good?
With all the positive qualities of the decentralized finance sector, it is believed that they are not at all decentralized, and therefore may be adversely affected by their superiors. DeFi has capitalized $5 billion in two years, essentially from nowhere. According to a Bloomberg representative, Wall Street traders are actively interested in the sector. Such a statement could say, that Wall Street traders are interested in all new and promising industries in the economy, so we can talk about anything. However, more than 50% of DeFi-enterprises are registered in the USA, which makes this statement truthful.
Investments from well-known companies and hedge funds, which we described above, cannot be discounted. When providing funds for the development of the platform, investors get the right to vote, which can sometimes be decisive.
This case was recorded in November 2019. Maker’s platform, which specializes in tokenization of fiat currency, held a vote to decide whether Maker is moving to a new multi-value system. Only holders of MKR internal token could vote. A total of 150 token holders with 160,000 MKR in their hands voted, with the exception of one nuance — 80,000 MKR held five recipients. Although the platform passed the management on to the users, but the solution will be for the group of people who have more MKR tokens concentrated in their hands, which is already centralization.
Based on this case , we can safely assume that MakerDAO- is not the only DeFi platform that has such problems. And the question remains whether it is a problem for those who are happy with all of this.
Decentralized finance- is a fast-growing sector in the crypto industry, which is poorly mastered and not large enough to draw any unequivocal conclusions about it. DeFi platforms provide advantageous credit conditions and facilitate the development of currentized assets that can bring new opportunities for traders and attract new faces to the crypto market. In addition, with the help of DeFi- services it is possible to save and increase funds, even during prevailing bearish mood in the crypto currency market.
However, at the moment, there is a need to be cautious about projects from the decentralized finance sector. There are no fully decentralized credit services, no matter how their representatives assure about it. At the same time, DeFi looks advantageous against the background of traditional financial system, which is experiencing bad times in crisis and pandemic conditions. Therefore, the sector has opportunities for development, and we will know what it will be like- in the future.
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