Introduction to Decentralized Finance (DeFi) - Blockchain Tech
If you’re living in a tech friendly environment, at least one of your friends cornered you during a party while you were just trying to focus on a mojito’s recipe to tell you the insane possibilities of Blockchain technologies (usually, I am this joyful -yet ennoying- person).
Today is about the rise of Decentralized Finance (DeFi). You’ll love it. All the friends I cornered the past few months would agree. You don’t necessarily need to understand the technology well to perceive the potential impact on society.
However if you need a refresher, here is a quick review from this article about what is a Blockchain protocol.
A blockchain is a network of multiple devices (nodes) — all equally important — connected to each other through the internet. Essentially, a blockchain is a ledger which stores the record of what has come in and gone out in a distributed p2p manner after the transaction has been verified by all participating nodes.
This distributed ledger works on pre-defined rules which are agreed upon by all the participating nodes (the peers) in the network. These rules include:
- a how-to for governing and validating transactions,
- an algorithm that defines the mechanism for all participating nodes to interact with each other, and,
- (in some cases), application programming interface.
These rules that govern a blockchain network are referred to as a protocol. It is essentially the common communication rules that the network plays by.
(Source: What are Blockchain Protocols and How Do they Work?)
What is DeFi?
The world of crypto-currencies is growing along with its needs. Not long after the first Bitcoin burst, we saw innovations as Initial Coin Offering (ICO) that were the logical continuity of business responding to new market opportunities.
Players with increasing exposition on cryptos wanted to borrow or lend for a project, or find a way to hedge their risks etc… Basically, as everytime in History when a traded asset appeared, Finance followed.
One of the first major evolutions in the world of DeFi was stablecoins. You can trade then secure a profit by switching back to crypto-currencies pegged on the dollar with a very low slippage and a resilient structure. Stability was a big downer, now fixed. Bear in mind that you’re paying taxes only when you convert your crypto profits back in fiat currencies: these are not.
MakerDAO was one of the first successes: it’s a decentralized autonomous organization (DAO) that lend the stablecoin DAI -a USD-pegged cryptocurrency with 1DAI=1$.
The governance is decentralized because the organization not only produces DAI, they also have a governance token (MKR) that you can buy/trade and that gives you a right to vote. As of the end of April 2021, $10.68B were locked in MakerDAO (TVL).
Two other lending protocols are worth mentioning, AAVE and Compound. You can deposit or borrow cryptos, including stablecoins, using the collateral and interest system like a normal bank. However, you can deposit Bitcoin or Ethereum as a collateral (with LTV of 50-65%), you cut costs from middlemen and interests are much higher.
As of the end of April 2021, respectively $9.83b and $9.18b were locked in AAVE and Compound. Rankings are moving fast so if you want to have an eye on that you can check DeFi Llama.
DEXes are quite big in DeFi too. It stands for “decentralized exchange”: everything is “on-chain”, which theoretically prevent hacks that could happen in centralized exchanges (Binance, Gemini). Uniswap uses liquidity pools instead of order books, as Curve Finance or SushiSwap.
Derivatives appeared, with protocols like Synthetix. It supports about 30 assets such as fiat or gold, but in a near future the company officially plan to create derivatives for stocks and index funds/ETF. This bridge between the two worlds would be another big milestone for the maturity of the market, as it will greatly improve reallocations between traditional assets and cryptos.
What about payment in real life? Several projects around credit cards and daily payments, including Flexa, the fully decentralized payment network. Paypal is also investing in this technology, as you can already buy cryptos from their platform and a rumor says they are working on their stablecoin to facilitate transfers.
To sum up, think about something -anything- and you’ll find the decentralized version… You need an insurance? Try Nexus Mutual. You need to source real-life data (stock market indexes, football games result…) to use in decentralized projects? Try an Oracle as Chainlink. You want to bet your retirement plan on a crypto that has no use but benefit from people with money to loose and others that hope to make money before people with money to loose leave the game, try Dogecoin.
However, it’s only the beginning because the real vertiginous perspective comes from the implications of DeFi on our societies. This article was only an introduction to my thesis: DeFi is a milestone toward a crypto society (click here to read the next article).
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Etienne Louvet-de Verchère is the founder of Huacachina Strategy which provides consulting services on strategy and investment with a special focus on technologies and sustainabilities.
