Why DeFi Matters in 2021
Part I: Introduction to DeFi and market trends
Decentralized finance—often called DeFi—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain.
Introduction
Decentralized finance has seen a surge in demand as we huddled in our homes weathering out the Covid-19 pandemic which coincides with the rise of day traders and meme stock trading as Gen Z and millennials look out for the next moonshot opportunity. 🚀 For those who are new to cryptocurrency and DeFi, one might assume DeFi is closely related to speculative trading and dog-related coins such as DodgeCoin and Shiba Inu but in reality this is farther from the truth.
DeFi is changing the way Gen-Z and businesses transact with their money and I hope this piece will provide you with a better understanding of the DeFi space, how it is revolutionising centralised finance and why the future of money has arrived.
Background
Before we dive into DeFi, I thought it is crucial to have a better understanding of Ethereum and why Garry Tan of Initialized Captial would call it “ultrasound money” . (Great video, check it out!) Ethereum is a decentralized, open-source blockchain with smart contract functionality and is the second largest cryptocurrency by market cap of over $200B. While Bitcoin was focused on being the first peer-to-peer digital currency, Ethereum focused on being the infrastructure in which other financial applications can be built on top of. Similar to Bitcoin, the Ethereum network has a token (Ether), a blockchain, nodes, and miners.
Ether is the native token on the Ethereum network. The token is used to incentivise miners to run their mining hardware (which helps keep the network decentralised). Ether tokens can be used for payments between users like Bitcoin or used to power smart contracts. The Ethereum token has two main token standards namely ERC-20 and ERC-721. The ERC-20 introduces a standard for Fungible Tokens which means they have a property that makes each Token be exactly the same (in type and value) of another Token.
ERC-20 - A standard interface for fungible (interchangeable) tokens, like voting tokens, staking tokens or virtual currencies.
ERC-721 - A standard interface for non-fungible tokens, like a deed for artwork or a song.
Tokens can represent virtually anything in Ethereum:
Reputation points in an online platform (E.g. Bitclout)
Collectibles of sportsperson (NBA Topshot, Fantastec)
Character in a game (Axie Infinity )
Fiat currency like USD (Stablecoins like USTC, USDC, Dai)
Characteristics of DeFi
DeFi aims to replicate centralized finance through the blockchain ecosystem and this can be achieved with key characteristics of DeFi namely non-custodial, open, transparent, composable, and decentralized. As Ethereum is a public and open blockchain, all transactions are recorded and verifable by everyone. An example would be Etherscan which is a tool to help you view data regarding any pending or confirmed Ethereum blockchain transactions.
Non-Custodial: distributed networks allow people to have control over their own assets without the need to use intermediaries.
Open: networks are also global allowing money to be transferred globally, seamlessly and creatively.
Transparent: Code for these financial applications are open-sourced which allows anyone is able to verify how the applications and protocols work, and track exactly where their money is.
Composable: Open-source code also enables developers to build on top of others’ applications, accelerating innovation and allowing applications to leverage on each others’ value.
Decentralized: DeFi protocols are built on public blockchains like Ethereum and are built to be managed by a community of users, and not centrally controlled
Market trends
There are over $53.5B worth of value locked in Ethereum smart contracts with the total value locked (TVL) in decentralized finance projects rising by 2,000% since May 2020. Decentralized finance has emerged as the most active sector in the blockchain space, with a wide range of use cases from lending, exchanges, and even currency in the form of stablecoins. DeFi are crypto assets can now be put to use in ways not possible with fiat or “real world” assets. Another factor spearheading the adoption of dencentralized finance is the development in blockchain wallets that are compatible with multiple blockchains running financial decentralized apps (dApps).
In addition, 74% of all stablecoins are issued on Ethereum (worth about $20 billion) which makes it easy to transact across borders, fully auditable; and interoperable with the rest of the Ethereum network. The number of DeFi protocols and cross-protocol activity of users has expanded and DeFi allow financial services, which was once exclusive, to bank the underbanked and improve financial inclusion across the world. Crypto assets provide people the opportunity to be their own bank without the need for intermediaries and represents a major shift in capital allocation for over 1.7B adults who currently do not have access to banking services.
Final Thoughts
Human beings have long used currency from natural objects to coins to paper to digital versions as a method of payment, a standard of value, a store of wealth and a unit of account. The Mesopotamian shekel – the first known form of currency – emerged nearly 5,000 years ago and changed the way mankind traded with one another. Similarly, DeFi should be viewed as the next medium for us to transact with one another, and one that remove the intermediaries and shifts control back from institutions to individuals and communities.
The FinTech Pulse aims to shed light in the exciting and somewhat complex world of FinTech and DeFi based on my experience as a venture capitalist and aspiring founder.
Huge shoutout to Jonathan Hua, Scrum Ventures for encouraging me to start my own newsletter and the rest of the team at Scrum Ventures where I had the opportunity to dive deep into FinTech and DeFi.
Feel free to reach out to me on LinkedIn and Twitter and would appreciate any feedback.
Brutal honesty trumps hypocritical politeness - Vinod Kholsa