The Rise of Decentralised Finance and its Key Players

Today’s goal of cryptocurrency is to make money and payments universally accessible. Every person, no matter where they are in the world, should be able to access and transact digital currencies.

However, decentralised finance (DeFi) decides to take this mission one step further. Imagine all the traditional finance products you are using like savings, loans, insurance, and trading. DeFi (or open finance) wants to make these financial services accessible for anyone with a smartphone and internet connection without the need to go through a centralised bank.

Definition of DeFi: “An ecosystem comprised of applications built on top of public distributed ledgers, for the facilitation of permissionless financial services.” - Philipp Sandner

During 2019, DeFi has seen impressive growth. Many DeFi products saw a large adoption. A report released by Binance Research revealed that DeFi became one of the critical growth areas for Ethereum since 2019. In particular, decentralised exchanges play a critical role in the DeFi space as they represent 90% of all the DeFi users.

Binance Research also revealed that there was a growing interest throughout 2019 for financial DeFi products besides exchange-related DeFi products. The below graph shows the monthly unique users in Ethereum DeFi. The last month of 2019 broke all records with 25,925 single users who used financial applications on Ethereum.

Source: DApp Review, Binance Research.

The price to the most popular DeFi application goes to MakerDAO who’s responsible for $388 million dollar worth of locked Ether.

This article will cover the importance of DeFi to boost the blockchain and crypto space. Besides, an overview of the top five DeFi projects will be presented.

Benefits of DeFi

DeFi can be seen as a second layer of applications on top of a blockchain. These applications are able to create a system of open finance, disconnected from any type of traditional finance. So, what are the benefits of such open finance system?

• True decentralisation removes any censorship. Users are free to choose which financial instruments they want to use and when they want to use them. Arguably, we can say DeFi brings true financial freedom.
• Worldwide participation in open finance, providing everyone the same chances to access financial products. In addition, DeFi has the ability to balance out markets between different countries creating a fairer global economy.
• Full control over your money without the need to trust any third-party with your money.
• Full financial transparency across all markets.
• Corruption or any sort of misbehaving is governed by decentralised financial protocols.

Lastly, the most important benefit is the cost that comes with traditional banking services. A lot of money has been put in the creation and development of centralised tools and banks to create a sense of trust.

A decentralised finance system comes with less overhead, more transparency, and most importantly, with a significantly lower cost than traditional finance systems.

Possible drawbacks of DeFi

As we are looking on the bright side of decentralised finance, let’s analyse DeFi from a different perspective. 

Obviously, decentralised finance is still in its infancy. We find low liquidity which makes it sometimes hard to complete transactions for DeFi products. Additionally, there is still a strong lack of clarity from a regulatory point of view. 

Some expect the true adoption of decentralised finance from the moment governments across the world start to embrace and regulate DeFi applications. There is a need for open finance, however, there is also a need for some sort of regulatory body overlooking the whole process or providing advice.

DeFi: The 5 most notable projects

Let’s discuss five of the most notable decentralised finance projects. First of all, let’s explore Compound.

#1: Compound - Earn a return on non-yielding digital assets

When we want to explain Compound’s finance protocol, we have to understand the concept of yield. The Compound Finance protocol allows individuals to ‘trade the time value’ of a digital asset. Therefore, yield is defined as the income that is returned on investment. 

However, for non-yielding digital assets, there is no income to be made. Blockchain assets have a negative yield through storage costs and the risks associated with them. This contributes to the strong price volatility as holding is disincentivized.

Therefore, Compound’s finance protocol takes an innovative leap by enabling individuals to use borrowed assets for investment use. Furthermore, this enables lenders to earn yield on non-yielding digital assets.

In short, by enabling individuals to earn a return on non-yielding digital assets they try to reduce the volatility and bridge the gap between lenders and borrowers.

#2: YouHodler - Turbo Lending and Multi HODL

YouHodler is one of the younger fintech platforms that focuses on crypto-based lending. However, it tries to leverage the lending industry by also offering crypto savings products and trading tools.

Recently, YouHodler has introduced a new powerful feature called Multi HODL which is based on the Barbell Strategy. For those who don’t know the Barbell strategy, I quote Investopedia:

“The Barbell Strategy advocates pairing two distinctly different baskets of stocks. One basket holds extremely safe investments, while the other only holds highly-leveraged and speculative investments.”

Source: YouHodler Multi HODL.

YouHodler implements this strategy in combination with the 80-20 rule. This means that 80% of your capital is invested in safe, risk-free assets. For YouHodler specifically, this sum of money is deposited in a savings account with an annual, guaranteed return of 12%.

Meanwhile, the remaining 20% gets invested in higher risk trades which have the potential to return high profits. However, you as an investor are only exposed to a possible risk of losing half of your capital.

Lastly, YouHolder offers a “Turbocharge” product. This investment product is based on the “cascade of loans” principle. This means you open multiple loans to increase your funds and every loan acts as collateral for another loan in the chain. Next, you can use this money for trading.

In short, the “Turbocharge” feature is pretty similar to margin trading, however, the mechanics behind the concept are different. YouHodler’s Turbocharge feature lets you receive an x6.5 boost of your capital.

Additionally, what makes YouHodler most unique is their incredibly high LTV of 90% which is found on both the platform’s classic crypto-backed loans and Turbo Loans.

#3: Synthetix - Decentralized synthetic assets

The Synthetix platform enables the creation of on-chain synthetic assets (Synths) that track the value of assets in the real world. For example, we can find synthetic fiat currencies such as sUSD or sAUD. Besides, synthetic commodities exist such as gold (sXAU).

Source: Synthetix

The idea is that you can receive the benefits of holding an asset without actually holding it. You may wonder why you don’t want to hold the actual asset? Good question!

To answer this question, I will take a look at my personal finance. Recently, I’ve bought a bit of physical gold as an investment. However, I noticed that it’s not an easy task to quickly buy or sell gold. In case you want to sell gold, you have to make a physical appointment. Hopefully, a few hours later you can actually sell your gold.

Problem? The price of gold might have been plumped already and you lost your favourable selling opportunity. In addition, we don’t speak about the costs of safely storing gold. 

If you take those arguments, it makes sense to be able to quickly trade gold without actually holding the asset and having to deal with custody.

From the Synthetix blog, we can read: “We believe Synthetix will play an important role in the proliferation of DeFi. By creating a generalised protocol to issue synthetic assets through collateralised SNX, developers and crypto investors can now gain access to a range of traditional and digital assets. Ultimately, SNX provides a framework to bridge DeFi and legacy finance derivatives.”

In short, Synthetix is a great project that tries to bridge DeFi and legacy finance derivatives.

#4: Dharma - Lending without a centralised bank

Dharma has been developed as there is a huge need for transparency in the debt markets. At the moment, debt makes up nearly 85% of the total global wealth. 

Dharma enables anyone to quickly and efficiently borrow money. The project defines itself as a P2P lending marketplace where everyone retains full control over their funds. 

The project introduced underwriters who are agents that identify the risks associated with a loan. Their job is solely to accurately identify the potential for default and liquidity risk and issue an approval or denial for a loan. Normally, a bank would trust on underwriters such as Morgan Stanley, Goldman Sachs, or J.P. Morgan. However, we have seen how things can go wrong in a non-transparent traditional finance market.

Therefore, Dharma reintroduced underwriters who are incentivised to effectively and accurately assess loans.

Benefits of using Dharma?

• Transparent debt issuing
• Ability to trade tokenised debt on Dharma’s platform
• Lend and borrow money at risk defined interest rates

#5: MakerDAO - CDP for stable coin stabilisation

Source: MakerDAO

In short, MakerDAO is the protocol behind the well-known stable coin DAI. The special thing about DAI is not that it’s pegged 1:1 to the USD but  that it’s backed by Ether instead of an authorised 3rd party who controls the supply.

Interestingly, the project didn’t conduct an ICO. However, they gradually started selling MKR tokens to fund their operations. However, it’s not an easy task to combat crypto’s volatility characteristics. 

Therefore, Maker designed a smart contract platform that allows users to open Collateralised Debt Positions (CDPs). This allows users to actively participate in lending services while at the same time stabilising the network. The more CDPs that get opened, the more stable the DAI token becomes. It’s definitely a unique concept to stabilise a stable coin and provide it with permissionless governance.

The Future of DeFi

DeFi is expected to grow in the upcoming months as there is a growing interest for decentralised or alternative financial products outside of the regularly banking system.

This increased interest for DeFi is likely to grow further due to the extremely low returns for saving accounts. It’s even expected a negative savings rate will be introduced.