DeFi and its two core attributes


Efi Pylarinou is the founder of Efi Pylarinou Advisory and a Fintech/Blockchain influencer – No.3 influencer in the finance sector by Refinitiv Global Social Media 2019. 

MakerDAO was the dominant player in the DeFi market for a long time. It was a lending protocol with two tokens, a stablecoin coin pegged to the USD (DAI) and their protocol token (MKR).

These were the days that the entire amount of Ethereum locked in Defi protocols was c. $500,000 (c. March 13, 2020). And then suddenly, the explosion of Defi tokens was upon us. Last year in September Ilias Hatzis wrote `DeFi will eat traditional finance and dramatically expand the global lending market`. He reported that Celsius, lending rates were 10+%, in partnership with Cred also offered 10+% on BTC and BCH; Binance lending (centralized) offered 15% to BNB token holders for their ETH and Tether holdings. At the time, Celcius and Nexo were the rising stars of the centralized lending cryptocurrency space and Uniswap, MakerDao were in the decentralized space.

I recall spotting dYdX which is focused more on margin trading for cryptocurrencies in a more decentralized way.

Today, `the Defi FAANGs` include Compound, Uniswap, Aave, and MakerDAO (but not No.1 in market cap or growth rates). These are my picks and they will surely change. They serve only one purpose: To highlight the Defi variety and main characteristics, without getting into technical details of how these protocols function and what their differences are.

Defi remains complex and for people that don’t have MetaMask accounts or some such, it sounds all Greek to them. So, what is the big deal and what does this craziness (in terms of price activity) imply?

In the Blockchain space, there are two painful major events that have had long-lasting ripple effects. The first is the DAO hack in June 2016 and the second is the ICO implosion in 2018. The first is a governance issue and the second a regulatory issue.

Both of these have been behind the slow development of DEXs (Decentralized exchanges) especially the non-custodial ones.

Non-custodial are those that the ownership of the assets can never be revoked. Two years ago in my article Are Decentralized Exchanges part of the Bottom-up decentralized monetary policy? I wrote about Kyber Network (a DEX) and addressed the non-custodial attribute that varies by exchange.

The Defi space is not only about peer-to-peer lending in a decentralized way. There are Defi protocols and Dapps that are exchanges, others for trading/investing, and others for derivatives. The Defi world is experimenting with decentralized ways of the main conventional building blocks of finance: trading spot (i.e. swapping one asset for another with no intermediary and no one holding your assets), trading on margin or getting funded, lending-borrowing, and investing.

DeFi is mainly about the non-custodial aspect in any of the financial transactions I mentioned above. So, you can think of Defi as a genuine innovation in the governance of financial transactions. We have started with the basics: swapping assets, loans, trading on margin, and earning interest.

DeFi has introduced the innovation of governance tokens that act as an incentive and reward to token holders. For the first time, we are combining voting rights with financial rewards. In the conventional world, we all understand the power of voting rights but they are not connected with more direct yield, there is no market for them etc. Jack Ma owns 8+% of Ant Group shares but over 50% of the voting power. However, these rights are not tradeable or divisible.

Compound protocol and its $COMP token is a good example of a DeFi lending protocol with a governance token. You can lend your cryptocurrencies (in a non-custodial fashion) and borrow another cryptocurrency against your assets. This typically requires over-collateralization (c.150%) but you will earn interest and governance tokens that have often had capital gains that exceed the interest payments.

DeFi right now is offering exorbitant rewards for those taking the risks of experimenting with DEX protocols. These rates are not sustainable however, these protocols and Dapps are showing us the way governance can work. These are the new DAO experiments that are emerging.

Uniswap, the current leading in market capitalization, is a good example of a DeFi DEX. In plain words, this is an Automated Market Maker (AMM) that creates liquidity pools so that instead of an order book acting as the backbone of an exchange, we have smart contracts processing the transactions needed to swap one asset with another.

Yearn.Finance is the leader currently in yield farming. This is the next generation of Staking tokens. In plain words, you lock up your holdings in a lending protocol and you earn interest plus governance tokens; and you are not stuck in a protocol but you can move across protocols and get the best interest available.

New readers can see 3 free articles before getting the Daily Fintech paywall. After that you will need to become a member for just US$143 a year (= $0.39 per day) and get all our fresh content and our archives and participate in our forum.


Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.