As written in our last post nearly 1 year ago, DeFi was the buzzword at the moment. It was always the plan from the beginning to decentralize finance and put the power into the hands of the people. Basically DeFi brings everything you currently see in traditional finance to the blockchain. This means that the user is not dealing with a middle man, or a rent seeker as they are called. They are interacting directly with a “Smart Contract” which is usually audited code that secures these transactions. It is done through digital wallets like MetaMask that enable these secure transactions through the use of the Ethereum network – the worlds biggest and most used blockchain currently in existence. Furthermore, the benefit to these decentralized financial applications is the fact that users do not need to be accepted by a traditional financial institution or bank to participate. This can allow an individual in a developing country the ability to participate directly from their PC or phone, as most of these DeFi apps have a mobile format to make it easier.
To reiterate, DeFi does not require a Third party to operate – or middleman. You the user are free to enter and exit these ecosystems without the permission of anyone. Can you imagine how incredibly explosive this will be in the future? This is due to the unstoppable nature of computers and code. Given that code rules all in blockchain smart contracts, it is not possible to stop the growth of DeFi. Now, some DeFi platforms are custodial, but the majority of them are not. The reason why there are custodial platforms is because new users sometimes need to be ushered into the space with hand holding as it can be a complicated world to enter. Now, many “Normies” will question the validity of these networks, and some may feel threatened by them. Just as in our last post we drove home the point that computers were emerging faster than anyone had expected. This is the case with DeFi as these platforms will never cease to exist. It is just the beginning and these are the early stages of a new financial frontier where anyone can be included.
At the essence of any new emerging DeFi protocol is community. Community means users. The amazing thing is that community is spread out globally and with that comes extremely fast adoption. If a new user benefits greatly from the use of these DeFi tools they are sure to bring their friends to learn the benefits of DeFi. DeFi allows anyone, anywhere in the world with a phone or PC, the ability to earn cryptographic tokens which can be exchanged at value. Tokenization was the game plan from the beginning, and every Token carries with it a community of enthusiasts who want to see through that the protocol is successful and thrives into the future. It is critical for every new venture to build and support the people who support the protocol. We can see a strong emergence in DeFi in Africa and in this video the president of South Africa discussing its growth:
While some nations have sought to outright stop the growth of these blockchain protocols, others have encouraged the growth of DeFi. This leads to the famous expression “Bank The Unbanked”. With all of that being said, lets be realistic. Most of the activity happening in DeFi is with more technically savvy types, who have been past users in the Crypto ecosystem. That will all change sooner than expected as ease of use is one of the main goals of many new startups in the DeFi space. Robo advisers will continue to proliferate and help new users onboard to decentralized finance. It should also be noted that this really cannot be stopped as DeFi is code operating with Smart Contracts. For those who do not understand what a Smart Contract is the following definition will help you understand why DeFi is so powerful:
A smart contract is a computer program or a transaction protocol which is intended to automatically execute, control or document legally relevant events and actions according to the terms of a contract or an agreement.Wikipedia
What are the Risks of DeFi?
Given that DeFi is an entirely new financial ecosystem, it is not without its risks like anything else. Hacks have taken place which have drained protocols of funds and caused participants to lose money. The most important element is doing your own research and understand what platforms you are engaging in. It also helps to see if the code has been audited by a team of security researchers. Users need to educated themselves on security best practices and understand the use of the many wallets that exist, namely MetaMask which is the most popular wallet for DeFi participation and used in tandem with a variety of platforms and decentralized exchanges. Another important practice is understanding the value of cryptographic tokens, and at what point you feel comfortable to invest in these for the long run. At blocktrak, we believe in “hodling” for the long run. This means projects that have been heavily researched, audited and battle tested. Projects which are here to stay in the DeFi ecosystem. It will be entirely up to the new user to learn and understand these different platforms and protocols. Education is key with blockchain.
One of the popular sayings in the Crypto world is “Trust but Verify” and that holds true when approaching any sort of new DeFi platform, checking for audited code, exceptional developers, and support from known blockchain funds and organizations. Trust can also mean lesser gains. If the protocol is new it may offer a greater tokenized incentive for new users versus a very popular audited platform with less reward (high risk high reward). So while the projects continue to develop and being in the early stage that we are in, expect for an increase of simple onboarding to usher in mainstream users on a global scale.
Differentiators – Centralized vs Decentralized
Its very easy to understand the word decentralization. If you know what decentralized means and you know what finance means, you put 2 and 2 together. Centralized finance is custody of your assets using middle men. Crypto is non custodial, (if you want it to be). Some newer crypto users are opting into custody based solutions as they are not interested in the management and security of their crypto and want the assurance that if anything goes wrong it will be taken care of. This is why the more mainstream investors are yet to jump in with both feet, and as we stressed previously, learning to manage the many wallets can be a frustration for the non tech savvy. Regarding governance, custodians of traditional finance make most of the decisions, not the investors. In DeFi, the community has the ability to decide the direction of the protocol through the use of voting tokens. Now, some of these token models are currently being upgraded to give more to the users as in the past tokens could be mainly held by the top investors or the platforms themselves. There has been much discussion on this as of late.
Other differentiators would be interests rates which are usually determined in a discretionary way while crypto APYs are market rate. Risks are also a bit higher when decentralization comes into play as the code may not have been fully audited, and the users would need to be somewhat tech savvy and well educated in DeFi to make the best decisions for themselves without losing any of their funds. Not every blockchain company is decentralized, and we see clear examples of that looking at any of the many centralized exchanges such as Binance. While Binance is one of best exchanges in the world, built by one of the most talented engineers who made the cover of Forbes magazine in 2017, it is still a centralized exchange. Users are encouraged to KYC to gain greater benefits with the exchange and Decentralized exchanges do not have these requirements as they run solely on audited and non audited code. Some other Centralized blockchain platforms are Nexo, and Celsius network. Again, these centralized custody solutions are aimed at capturing mainstream users and helping them navigate the complicated DeFi world. It is really up to the user of the platform to determine how decentralized they want to go, and how much they want to learn as many simply do not have the time to educate themselves on the complications of DeFi.
Some of the elements of centralized Crypto include: private key management (not your keys not your coins), governance, oracles which would come from one source verses multiple sources, and a wide range of varying interest rates. In general it is not advised to let someone else hold you private keys but it can be a relief for newer investors who want to bring liquidity to the tokenization world and do not want the personal responsibility of large amounts of funds – they want to leave it to the experts to manage their money. This can be a good solution to usher in new investors, increase the value of the the crypto markets and make retail feel more comfortable as they enter DeFi.
Which Blockchain is most efficient for DeFi?
Yes, in the world of blockchain there is One reigning supreme – Ethereum. Built and envisioned by technical visionary Vitalik Buterin in 2015, it is the most well known blockchain currently in existence outside of the Bitcoin blockchain. The idea behind Ethereum was to build decentralized things on top of one blockchain that can allow for anyone in the world to create their own vision of the new web (Web3). The Ethereum ecosystem has many facets to it and a diverse group of people behind these applications. Some of them are in the decentralized finance niche, others in gaming and art (NFTs). The Ethereum community or Etherean community is widespread and has a number of organizations and funds dedicated to this new vision of how the web can be. There is no doubt that Ethereum has the highest number of developers and support than any existing blockchain. The number of blockchains has been growing with the likes of Cardano, Elrond, Solana, Polkadot, Tron, Tezos, Avalanche, Zilliqa, Icon, NEO and many others supporting Layer 2 like Polygon (formerly Matic network). Furthermore projects like IPFS, Filecoin, and 0chain aim to decentralize storage away from centralized servers. One of the more ambitious projects is Dfinity, which wants to fully decentralize the web.
As of today, the blockchain with the strongest network effect continues to be Ethereum. These new chains listed above are still in development, some of them being fully launched and attempting to bring developers and new ideas to the growing platforms. One of the biggest set backs for the Ethereum chain is known as “Gas” and this is simply a fee to pay the network for participation in transactions. The “miners” who validate these transactions are paid a fee through the Gas. This has not necessarily effected the blockchain transactions as the applications focused on DeFi are built on Ethereum and TVL (total value locked) on these platforms keeps going up in the Billions. With all of this being said, most of the development community is supporting the Ethereum blockchain and do not have plans to switch any time soon. Ethereum also plans to upgrade its infrastructure to make fees more manageable and less costly in the future. Most are confident Ethereum can forge ahead into the future and become the Oil of blockchain. While we at blocktrak are mega bullish on Ethereum, it is wise to keep an eye on the development of new blockchain technology and learn what is emerging.
Which DeFi platforms to use?
While the amount of activity in DeFi can be quite dizzying, we highlight some of the more popular protocols and encourage readers to take a look at each of them and test some of these out. Currently AAVE is the open source liquidity protocol built for “Normies”. It simply allows participants to earn interest on deposits. You could also borrow crypto assets. For those out there who have always dreamed of earning passive income, this could be your ticket (if you fancy Tokens). Currently over $5 Billion is staked across AAVE. The tokens can be obtained from a centralized exchange or a decentralized exchange like Uniswap. Scroll through the list of Tokens and see which pairing may interest (no pun intended) you. To add to that, Uniswap is the opposite of Binance. Users simply install the MetaMask crypto wallet to their Chrome, Firefox, or Brave browser and enter the website. With a little Ethereum loaded into the wallet, users can easily “swap” for their favorite Tokens. Think of it as a Token shopping mall. You then add these Tokens to your ERC-20 friendly wallet (Ethereum based Tokens) and go over to AAVE and begin your Staking for APY journey. For most new users in Crypto, this is the best solution as it is low risk, safe and secure. As always it is important to use caution to make sure you are on the right website, and that you have followed basic OPSEC. You can then deposit your “coins” and watch the rewards go up. Every stake tells users how much interest they will make, so you know before you go.
One of the more popular Ethereum based Tokens that can earn higher interest is known as USDC. This means US Dollar Coin. It is a stable coin backed by the price of US Dollars. Because of the massive volatility of crypto over the years, Stable coins became a way to peg value to a stable asset while quickly being able to trade in and out of that stable coin token to secure the value of their assets. Many traders prefer a stable coin like USDC which is backed by some of the larger crypto institutions like Circle. Another popular platform is MakerDAO which has pioneered the DAI stable coin. DAI is a stable coin that is fully decentralized and programmable. It is used across a wide range of decentralized finance applications and wallets. MakerDAO also allows anyone, anywhere in the world to lend themselves Cryptocurrency with the use of their DAI stable coin. For those who do not know, DAO stands for Decentralized Autonomous Organization. These are blockchain based groups who decide on the future of protocols being developed and decisions on how things are run within the organization through voting systems.
Another super popular DeFi protocol is Yearn Finance. This network allows users to maximize their DeFi APY rewards through lending and trading services. (Currently the price of YFI Token is above Bitcoin!) due to its scarce limited supply. Users navigate the protocol and discover how to put their crypto funds to work to earn them even more crypto, and we all know this is going to drive more and more users to DeFi. The practice has been coined “Yield Farming” and this pretty much means what it says. You stake and grow your crypto assets. You interact with the platform in exchange for the networks very own Tokens, which can then be traded for the digital asset of your own liking. To many, this is a thrilling experience and overall the DeFi markets are now in the multi billions. These are just a few examples of how, why and where DeFi works, but there are hundreds of emerging projects now and it is important to follow our guidelines and do your own research before depositing your funds into these smart contracts.
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