Understanding the DeFi universe

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A nascent financial paradigm is taking shape, an evolution from the current economic and financial system whose governance is highly centralised and controlled by authorities. The new paradigm centres on empowering users, promoting self-sovereignty and leveraging technology to open up financial institutions for individuals.

The DeFi system is open to everybody and not reliant on any central authority to make decisions. It democratises access to financial services by lowering the barrier of entry for those who — for a number of reasons — may not be able to access traditional bank accounts, loans or other financial products.

Welcome to the Decentralised Finance, the evolution of crypto.

Trading is one of the most ancient practices in society, when humans bartered goods and services to meet their needs, creating a very primitive form of market.

With social and technological evolution, trading became a more sophisticated activity, with the creation of specialised bodies such as banks and the introduction of money, allowing for a wider range of services such as credit.

As we moved into the digital economy, the use of technology for financial services has flourished in the FinTech industry, where innovative services and solutions are popping up like flowers. Today, smartphone banking apps offer multiple functions but still, most of the services are controlled by banks and a handful of financial institutions, leaving users with little autonomy.

The concept of hard money, once specific to gold, was transformed by a new monetary system controlled by central authorities in which an unlimited supply of fiat currencies could be printed and circulated, turning the dial of wealth. While this measure was meant to provide economic stimulus, unwanted consequences of this system came about, such as inflation and devaluation of money.

Over the decades, a skepticism towards centralised monetary policy started to grow. People are increasingly feeling the need to more in control of their wealth and have turned to technological innovation to find the solution.

Here comes Bitcoin, the discovery of absolutely scarce money.

No more banks, welcome to decentralisation

In 2017, when cryptocurrencies made an entrance into the general market, Bitcoin introduced us to the concept of decentralisation powered by blockchain technology. This meant that banks could take full control of their own finances, essentially rendering banks unnecessary.

Although full decentralisation is not yet a reality, it is a steadily growing trend which is certain to gain more prominence in the future. More classes of cryptocurrencies emerged after Bitcoin, harnessing the power of blockchain technology to build platforms for different applications.

Ethereum, the second largest cryptocurrency by market cap, provides infrastructure for smart contracts: a key aspect in a decentralised system. The hottest use case for Ethereum is now Decentralised Finance, also known as DeFi: a growing movement composed of initiatives that resemble conventional market services, offered via blockchain-built smart contracts with no need for intermediaries. DeFi platforms offer a range of financial services: lending and credit systems, infrastructure, decentralised dxchange (DEX), derivatives, payments, assets.

Imagine transferring money directly without a bank being involved? That’s what DeFi is about — democratisation of financial services. For those used to ‘old school’ finance, this can be a difficult concept to grasp, but it is necessary to understand the direction in which the market is heading. The DeFi industry’s total value locked around $675million in January 2020; now it is worth approx $9.6billion — a 1,322% increase in 9 months.

In our latest interview with Clem Chambers, renowned investment guru, award-winning financial author, and CEO of both London-listed financial news platform ADVFN (AFN) and blockchain developer Online Blockchain (OBC), says market investors must get used to the world of crypto and DeFi.

Potential investors should remember that DeFi projects are in the early stages, so caution is needed. Saying that, we can draw comparisons with the 90s tech boom; some DeFi projects could turn out to be the next Amazon or Microsoft, says Clem. It is an infant industry but ‘the winners are going to be worth a fortune in the future’. The key is to have a smart investment strategy and play carefully.

Watch the full interview with Clem Chambers:

The Ethereum 2.0 upgrade

It is important to note the large scope for improvement in the industry as many projects are still being established, so bugs and flaws in DeFi system can make some services rather risky.

The upgrade to Ethereum 2.0 aims to address the network’s scalability and security. Currently, the Ethereum network consists of a single chain with consecutive blocks, which makes processes very slow. The upgraded version promises to introduce shard chains to split up the blockchain, making it faster.

However, it is uncertain when the upgrade will take place. Some experts, like Ethereum co-creator and Cardano Founder Charles Hoskinson, have pointed out security flaws in the structure of Ethereum 2.0.

We will dive into each aspect of DeFi, covering the main projects. Let’s start with lending.

One of the DeFi’s most pertinent use cases is borrowing and lending tokens, which works similarly to the traditional system in the sense that people pay and earn interest. However, in the case of DeFi, all assets are digital. Smart contracts directly connect borrowers and lenders, enforcing the rules of contract and distributing interest all without the need for a bank as middleman. This is proving one of the most popular ways to earn passive income in this space.

DeFi Lending Projects to watch:

Aave: an open source and non-custodial protocol to earn interest on deposits & borrow assets. It allows users to earn interest on their cryptocurrency or borrow cryptocurrency in return of interest. Funds are stored on a non-custodial smart contract on the Ethereum blockchain. Aave is one of the most established DeFi protocols in the market. Aave supports a wide range of Ethereum-based assets, including BAT, ETH, DAI, USDC, TUSD, USDT, BUSD, and more. Deposit APYs (annual percentage yields) may go from 0.18% to 25.01% across all available assets, according to CryptoNews.

Maker: a credit platform which supports Dai, a stable coin whose value is pegged to the US Dollar and backed by digital assets as collateral. The purpose of Maker is to create an open credit platform combining the transparency and efficiency of blockchain with the stability of real-word currencies. Users go to Maker to open a Vault, where they deposit coins such as ETH or BAT as collateral and receive Dai as debt. Users can borrow Dai up to 66 percent of their collateral’s value (150 percent collateralisation ratio). Maker allows any user to take on a loan and have a cryptocurrency that provides price stability. Watch this short video to understand how Maker works: https://youtu.be/Gqu9GWcx9Wk

Compound: An open-source money market protocol on Ethereum that lets users lend or borrow assets against collateral backed by world-class investors such as Coinbase. Compound works similarly to a traditional savings account, with the advantage that users can spend their savings while still earning interest on it because of the tokenisation of the assets locked in the system. When users’ locked assets are converted into a token, they become freely movable, tradeable, and usable in other decentralised applications (dapps).

BlockFi: A platform offering institutional-quality financial services to crypto investors, including interest-earning accounts, low-cost USD loans secured with crypto and fee-free trading. BlockFi operates within regulatory guidelines at the federal and state level in the United States. Users can get a loan from BlockFi which enables them to use crypto assets as collateral and receive USD to the bank account. Interest is paid monthly and compounds, increasing account holders’ earnings.

DeFi is an evolving concept. Let us know your questions about the topic. Contact us via social media or at [email protected]

Be sure to follow us on social media @cassiopeia_ltd to keep up with more news and updates in this exciting sector, and don’t forget to subscribe to our channel to hear about further upcoming interviews on FinancialFox.