DeFi — An Overview
M&A PR Studio
Why Now
Many people called 2019 the year of DeFi. In 2020, it continues to be the prevailing trend. DeFi has replaced ICO as a term and is the “hottest” application of blockchain technology. Unlike many earlier crypto projects that were trying to build something completely novel, all DeFi protocols offer well-known financial products: lending, payments, and investments in assets and derivatives. Thus, it’s no surprise they all have measurable traction.
We have seen all kinds of news about this space and wanted to dive deeper to figure out the most notable protocols and projects — and how they stack up to each other.
Even with cities and countries locked down due to COVID-19, people still need access to financial services — maybe more than ever. One of the main value offerings of DeFi protocols is taking loans in stablecoins using your crypto assets as a collateral, something that should be in high demand due to the global economic crisis.
Definition
Decentralized Finance means building familiar and novel financial instruments on public blockchains through code. The resulting protocols are open to anyone, auditable, and interoperable, enabling developers to build composite products based on them.
Originally, financial products were built by banks and investment companies. Loans have existed since the earliest times, but the first ETF only emerged in 1989. It takes a collaboration of multiple parties — investment managers, regulators, and stock exchanges — to launch a brand new offering.
DeFi allows developers to build new products from scratch and combine existing protocols to make a consumer-facing solution anyone can use. These products are built on public blockchains and consist of protocols, digital assets, dApps, and smart contracts.
Some key aspect of DeFi are:
- DeFi is not managed by institutions and employees. Once a smart contract is deployed to blockchain, DeFi apps can run without any human intervention unless that option was added specifically.
- dApps are designed to run globally and are available to anyone on the planet.
- Anyone can audit the code, which enables trust from users.
- Anybody can create DeFi applications.
- New DeFi applications are built and composed by mixing existing DeFi products, like in the case of Lego. Take a decentralized exchange, a stablecoin, and an oracle and you could build an automated product that issues loans in fiat-nominated tokens.
DeFi Status
As of April 14, 2020, there is $739 million currently locked in the top 25 DeFi protocols, with a bit more than half reserved by Maker. These protocols provide derivatives and lending products, payments, asset ownership, and decentralized exchanges. The absolute majority are based on Ethereum and offer a good measure of the current state of the ecosystem. Even though these figures aren’t precisely the same, we can use them for reference. ICOs in 2018 raised almost $11.4 billion according to CoinTelegraph, suggesting the market has shrunk.
Using the data from DeFi Pulse, we wanted to look at the most notable projects in the space.
Top Projects
We located the five most notable DeFi projects based on the total volume of funds locked in their smart contracts. These projects are:
- Maker
- Compound
- Synthetix
- Aave
- UniSwap
We should take into account that the volume held by each particular protocol is affected by the price of its blockchain token (primarily ETH) to USD,. This reflects price fluctuations of the entire cryptocurrency market, not the demand for a particular decentralized finance service. As you will see, if we correct for the market price of ETH, the growth picture changes dramatically for each project.
And yet, it turns out that this method of accounting doesn’t include one specific protocol that ends up dominating crypto lending. According to data by LoanScan, dYdX has been the prevailing loan issuer among other DeFi protocols since Fall 2019.
The reason it’s only the 7th among other DeFi protocols is that the periods for those trades are much shorter — they are less likely to be usual loans in nature but represent margin trading. Most of them are repaid the same month, therefore the contracts of dYdX hold only a small volume of assets at any particular moment and aren’t that visible in the DeFi Pulse data.
We believe it’s important to highlight dYdX despite its lower share of locked assets and will include it in the short list.
- Maker
- Compound
- Synthetix
- Aave
- UniSwap
- dYdX
We can also clearly see that interest in DeFi is rising based on the volume of searches for the most notable projects. UniSwap tops all others — most likely because it’s a decentralized exchange and thus the most consumer-facing of all. The main value of others comes from their protocols, even if they have purely consumer-facing apps, such as Maker and its Oasis exchange.
Let’s look deeper into these particular projects.
Maker
MakerDao is a decentralized lending facility built on top of the Ethereum blockchain and one of the most successful examples of DeFi. The Maker platform uses smart contracts to automate a lending platform and provide an associated stablecoin which isn’t backed by USD directly. Instead, the platform is designed to build the market equilibrium at the price pegged to the USD based on the oracle data.
Maker wants to build a reserve bank for the decentralized economy, allowing people who hold MKR to vote on crucial decisions like Stability Fees that affects the market equilibrium, for instance.
As you can see, the volume held by the Market contract remained mostly the same since the start of the year if nominated in ETH. As ETH rates fell by almost 30% along with world markets, the loans’ collateral was automatically auctioned to cover outstanding debts. However, the infrastructure was unable to keep up with ETH’s plummeting value and receive the correct market price from the oracles in time, which led to collateral of some users being sold off for practically nothing. Maker ended up under-collateralized by at least $4 million.
That significantly affected users’ trust in Maker as they realized that, though the code is transparent, some unexpected factors might provide unpleasant surprises.
Compound
Compound is an algorithmic money market protocol that allows users to earn interest or borrow assets against their crypto collateral, where rates adjust automatically based on supply and demand.
Supplied assets are represented by cTokens. Users can borrow 50% to 75% of their collateral value, depending on the asset. They can add or remove funds at any time, but if their loan becomes undercollateralized it will be liquidated. Liquidators are also part of the market and get a 5% discount on liquidated assets as an incentive. The protocol now supports BAT, DAI, SAI, ETH, REP, USDC, WBTC, and ZRX.
Compound experienced a very noticeable growth around the end of February but as markets crashed, its usage adjusted and hasn’t recovered to previous levels yet.
Synthetix
Synthetix is a decentralized platform for the creation of Synths: on-chain synthetic assets that track the value of real-world assets. Originally called Havven when the project was focused on stablecoins, Synthetix later rebranded and expanded its offering. Synthetix supports over 30 Synths representing fiat currencies, commodities (e.g., gold), stocks, and crypto.
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