In recent weeks, Bitcoin has been the sweet spot of the cryptocurrency market for many investors looking to make an extra income, especially as the bullish run seems unabated since June. However, it is not the only part of the market getting all the attention.
Aside from some altcoins which have leveraged the bitcoin run to advance their market values, investors have also increasingly been writing many cheques in the decentralised finance ecosystem also known as DeFi.
An August report by Luno in partnership with Arcane Research described the attention in the DeFi ecosystem as a “wild summer” as yield farming frenzy has driven huge amounts of cash into the ecosystem.
What is DeFi?
It refers to a movement that aims to create an open-source, permissionless, and transparent financial service ecosystem that is available to everyone and operates without any central authority. The users would maintain full control over their assets and interact with this ecosystem through peer-to-peer (P2P), decentralized applications (dapps).
Put differently, DeFi is the notion that crypto entrepreneurs can recreate traditional financial instruments in a decentralised architecture, outside of companies’ and governments’ control. One of its major inspirations is Tether’s supposed failure to address financial corruption. In 2019, Bitfinex was accused of using Tether, a dollar-backed cryptocurrency, to cover up $850 million that went missing.
The first original DeFi applications are bitcoin and Ethereum, this is because both are controlled by a large network of computers, not any central authority. While bitcoin is treated like gold, as a store-of-value investment that protects against inflation, Ethereum has been instrumental in helping startups crowdfund their operations.
Dai is another DeFi application that is popularly used. According to data, about 21,000 people hold the asset. In early April, it hit a peak number of daily transactions at 13,490, up from less than 500 average daily transactions in the first few months after it was launched in 2017. MakerDAO is the decentralized credit platform on Ethereum that supports Dai, a stablecoin whose value is pegged to USD.
The surge in DeFi lending
Crowdfund or open lending is where DeFi has had a major breakthrough as it has become one of the most popular types of applications that are part of the DeFi ecosystem. Advantages include instant transaction settlement, the ability to collateralise digital assets, no credit checks, and potential standardisation in the future.
There has been a surge in entrepreneurs choosing this method to raise money for their business. Aave, a noncustodial lending protocol reportedly issued $138 million in loans with zero collateral in June 2020. In the last week of the same month, DeFi flash loans grew by 809 percent as the protocol Aave was issuing anywhere between $80 – 100 million in flash loans per day. By August Aave’s market size was at $662 million.
To be sure, the word “Aave” is a Finnish term to describe a ghost, as the noncustodial platform allows for lending interest rates to be guided by algorithms directed by the supply and demand. Flash loans are used for significant arbitrage opportunities and they allow people to obtain handsome loans without collateral.
The report Luno showed that the DeFi lending market has seen the largest growth, accruing a total of $2.9 billion in total value locked (TVL) with MakerDAO accounting for $1.5 billion of the value.
Currently, the billion or so dollars tied up in DeFi pales in comparison to the trillions of dollars in traditional, centralized finance. But, the excitement of rapid growth and the possibility of meaningful investment returns in a low-interest-rate environment is starting to pull some real money away from traditional investment.
DeFi is more than lending.
It incorporates other pieces including derivatives, stablecoins, asset management, insurance platforms, prediction markets, KYC and identities; infrastructure, and decentralised exchanges.
