in Decentralized Finance (DeFi)
What is DeFi?
DeFi (Decentralized Finance) is a catchall term for an entirely new financial system that’s being built on top of Ethereum.
- Instant loans
- Unique, digital art
- Savings accounts that pay high interest
- Decentralized financial products like crypto that tracks gold and US stock prices
It’s all there. Even though DeFi is still young, it’s growing up quickly and there’s a lot to be excited about.
To learn more about DeFi, read our Definitive Guide to DeFi.
In this article, we’ll cover some of the most innovative DeFi developments.
DeFi began in 2015 with the introduction of MakerDAO, a lending protocol that lets users deposit Ethereum in order to mint DAI, a stablecoin that tracks the price of the US Dollar.
MakerDAO was the first platform to show the potential of DeFi. No bank manager, no paperwork, no signatures, no credit checks. If a user had some ETH, they could deposit it with Maker and take out a DAI loan–that simple.
Since its introduction, the Maker platform has steadily grown in popularity, such that it recently became the first DeFi platform in history to accrue $1 billion in assets.
Given that growth is happening quicker now, and it’s possible to collateralize loans with other assets like WBTC and BAT, it shouldn’t be surprising if Maker reaches $2 billion sometime in the next year.
Advantages of Maker
- Anyone in the world can take out a loan and they don’t even have to provide their name. All that matters is that the borrower has collateral to back up the loan
- Low borrowing fees. As of publication, the interest rate on loans is 0%! Although it must be said that this rate can change at any time. Check DeFi Rate for a list of interest rates across platforms as well as 30-day interest rate averages
- Loans can be collateralized with multiple assets, not just ETH
Disadvantages of Maker
- The platform isn’t perfect. On Black Thursday, hundreds of borrowers lost all of their collateral due to a bug in the Maker platform
- Maker is less decentralized than it once was, thanks to their decision to accept coins like USDC and WBTC as collateral - both are controlled by third party organizations
Earn High Interest on Savings
A quick check of DeFi rates shows that it’s possible to earn anywhere from 3 to 10% interest (rates vary) by saving money (lending assets) with a DeFi protocol. Those are savings rates for stablecoins so traders don’t have to worry about the volatility of e.g. ETH’s price going up and down. It’s no wonder that DeFi is becoming so popular.
Compound Finance is one of the most popular crypto lending platforms in DeFi, and it’s now possible to access it directly using Exodus. Instead of having to send your DAI to Compound, you can start earning interest right from Exodus with just a few clicks of your mouse.
You can find out more about earning interest on Compound using Exodus here.
Yield farming has been one of crypto’s hottest topics in 2020. The basic idea is that investors can deposit their assets with a DeFi platform like Compound and earn a token for doing so.
For example, Compound decided to airdrop the governance token COMP to everyone using their platform. 50% of the airdrop went to borrowers and the other 50% went to lenders.
Given that COMP is a valuable token, there were a lot of investors who moved their assets to Compound in order to take advantage of this deal. Hence the term yield farming.
Since Compound came up with the idea to give away COMP, there have been other DeFi platforms that have tried the same thing. As more money comes into the space, we should expect even more platforms to try and incentivize investors into using their platform by giving away a token.
More information about yield farming is available in this excellent video from the Defiant DeFi channel.
Decentraland is crypto’s largest virtual land platform. What does virtual land have to do with decentralized finance?
Thanks to the lending platform Rocket, it’s now possible to use land from the Decentraland platform to collateralize a loan. In other words, the virtual equivalent of a home equity loan.
Socially Innovative DeFi
The current banking system is highly restrictive. Most people can’t even open a banking account if they don’t have a home address and identity documents. Thanks to these restrictions, there are hundreds of millions of people who can’t open a bank account.
Not only is that a restriction on savings, it means that these people can’t invest in the markets. If there is one thing we’ve learned in 2020, it’s that people who own assets do a lot better than those who don’t.
DeFi is different: anyone in the world can participate. The DeFi ecosystem doesn’t care about:
- Where you live
- Where you work
- Your gender, race, or religion
- Whether you have some plastic identity card
- What your name is
Anyone holding an asset like ETH or DAI can participate in DeFi. Users can earn interest on deposits, take out loans, buy land in Decentraland, trade futures contracts, etc. DeFi is the most socially innovative financial system the world has ever seen.
The White Whale: Non-Collateralized Loans
Currently, there is no way to take out a non-collateralized loan in the DeFi ecosystem. A non-collateralized loan is one that’s not backed up by an asset. A credit card is an example of this type of loan.
Non-collateralized loans have the potential to be huge and there are a lot of DeFi innovators thinking about how to make them work. It’s likely that the first non-collateralized loans will be based on some or all of these factors,
- History of asset ownership. I.e. Someone who has owned 10 BTC for five years is probably a low credit risk.
- Decentralized identity stored on the Ethereum blockchain. Unlike collateralized loans, non-collateralized loans will require the lending platform to know who they’re lending to.
- A loan that is backed up by the guarantee of another person or organization. I.e. a large corporation guarantees a loan for their employee.
In fact, it’s impossible to say exactly how non-collateralized loans will work but they are coming… They are the great white whale of the DeFi ecosystem and the first protocol or company to figure them out will stand to make a lot of money.
The Future of DeFi
- Traditional bank accounts pay almost no interest *** DeFi lending platforms pay great interest.
- People without the proper documents cannot open bank accounts *** Anyone can create an “account” in the DeFi ecosystem.
- Investors from certain countries cannot invest in popular financial products like the S&P 500 *** With DeFi, anyone can invest in a token that tracks the value of the S&P 500.
The more projects, the more solutions, the more people trust DeFi - the larger it will get. It’s truly an exciting time to be in this space as the early adopters will have the most opportunities to benefit as DeFi grows up.
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This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.