Decentralized Finance (DeFi) is slowly coming back to life as more people and institutions take an interest in this new paradigm of finance. According to a recent report by Dapp Radar, DeFi now accounts for 35% of the total activity within the blockchain economy. So, what are the fundamentals that are attracting big corporations like JP Morgan, Mitsubishi UFG, and BNY Mellon to the DeFi ecosystem?
For one to understand the value proposition, it is important to digest the fragmented and inaccessible nature of today’s financial markets. Big banks and investment firms have long been the intermediaries when it comes to financial services, a role that is now under threat given the external influence from large stakeholders and hurdles that limit small-time investors. DeFi seeks to change this narrative through decentralized and permissionless infrastructures.
Contrary to the centralized approach taken by financial institutions, DeFi leverages smart contracts to eliminate the middlemen. Simply put, the DeFi ecosystem is built on decentralized blockchain networks such as Ethereum, Fantom, and Avalanche. These ecosystems can be accessed by anyone with a non-custodial wallet, enabling people from all walks of life to access financial services that would have been a long shot in traditional finance.
Notably, DeFi has grown to over $206 billion in total locked value (TVL) as of press time; this is a significant gain from merely $1 billion at the onset of 2020. What’s in it for the common folk and institutions?
Well, there are several opportunities in DeFi, some of which are quite risky while others favor conservative investors. In the next section, we will break down the DeFi basket to paint a more detailed perspective on the decentralized market economy.
DeFi staking involves committing one’s tokens to support verification and network security in Proof-of-Stake (PoS) blockchains. Unlike the Proof-of-Work (PoW) consensus which requires computational energy, PoS networks rely on network validators who stake their tokens to keep the platform running and efficient.
As a result, staking has become one of the avenues in which DeFi users can earn a passive income. Some of the popular blockchains where users can stake their tokens include Ethereum and Polkadot. The former is currently in the process of transitioning into a fully PoS ecosystem and requires one to stake 32 ETH to become a validator. However, the emergence of staking pools such as Lido has opened up an opportunity for smaller investors to stake on Ethereum.
While staking is probably one of the safest ways to increase yield, it also comes with some inherent risks such as impairment loss due to the volatile nature of the crypto market. DeFi prospects looking to make an extra dime through staking ought to carry out proper due diligence and hedge the volatility through other positions, either in traditional finance or less risky DeFi investments.
- Yield Farming
Yield farming is another concept in murky DeFi waters. It gained popularity following the launch of governance tokens, which have become a popular tool in governing DeFi protocols. This DeFi category allows users to move funds around various protocols in search of better returns. In return, the yield farmers are rewarded with native governance tokens or other crypto assets depending on the incentive structure of a particular farm.
Back in the early yield farming days, most DeFi protocols were hosted on Ethereum but the tides have since changed, with innovators moving to cheaper chains such as Fantom and Avalanche. The latter is home to popular projects like the Pangolin DEX, one of the pioneer DeFi ecosystems to launch a super farm. Essentially, Pangolin features a multi-asset farm which means that users can receive various tokens as rewards.
It is also noteworthy that Pangolin is a 100% community-driven DEX, meaning that all its native tokens will be distributed to the community through yield farming, amongst other incentive programs. In addition, its existence on Avalanche makes it cheaper and faster for prospects to participate in the featured yield farms.
- Lending & Borrowing
Like traditional finance, DeFi features lending and borrowing protocols where users can provide and access loans. Some of the leading DeFi protocols offering this service include Compound and Aave. Essentially, one can lend or borrow several crypto assets at more favourable rates compared to the peanut returns offered by traditional banks and investment firms.
For instance, the Aave protocol features as high as 10% ROI on some of the crypto assets. This is far much greater than the average 0.06% interest rate for bank deposits in the U.S. That said, one needs the technical know-how to navigate DeFi lending and borrowing protocols to maximize the available opportunities.
- Spot and Margin Trading
DeFi has also enabled crypto users to pivot from centralized exchanges such as Binance which often require one to undergo a rigorous KYC process. Since the debut of Uniswap, Decentralized Exchanges (DEXs) have been gobbling up the market share to become the go-to platforms for savvy crypto users.
There are also DEXs like Primex that have gone an extra mile to feature both spot and margin trading. This Cross-DEX liquidity protocol allows users to trade multiple cryptos that are featured on different chains and exchanges. Furthermore, Primex leverages liquidity pools (buckets), enabling DeFi traders to access leverage for margin positions.
Given the current macroeconomic conditions, DEXs have proven to be a better alternative in hedging against geopolitical risks. It is likely that in the near future crypto users will avoid centralized exchanges, a trend that is already gaining momentum within the larger crypto community.
Despite being highly opposed by stakeholders in traditional finance, DeFi is more resilient than ever before. The next phase of innovation will usher in mass adoption from both individuals and institutions. However, early entrants stand a greater chance of reaping more benefits; after all, it is inevitable for the market to become diluted as more capital trickles in. DeFi will not only liberate the masses but create opportunities for new millionaires to be minted regardless of their background.