How does DeFi compare with the Traditional Financial Assets?
Most investors want to make investments that get sky-high returns as fast as possible with as little risk as possible. Investors are always on the lookout for different investment strategies to help them reach their goals.
The traditional financial industry has established many ways to invest — from less-risky investments such as CDs and government bonds to medium-risk assets like ETFs and funds, then to highest-risk picks like stocks. The wide variety of investment options means you can find an investment that fits your risk tolerance and time horizon. Then where do DeFi products come into play compared to the traditional financial assets?
DeFi is an ambitious attempt to decentralize traditional financial use cases like trading, lending, investing, wealth management, and payment using blockchain technology. However, to this day, DeFi has yet to achieve its goal of building a “decentralized” financial world, but rather offers investors a new way to allocate and grow their assets.
DeFi, like traditional finance, allows you to put your money into different assets according to your needs, but in the form of cryptocurrency.
DeFi products are assembled in a variety of different assets, contracts, and agreements that make them unique from one another. For example, Compound is a loan market based on Ethereum, where users can borrow ETH, MakerDAO’s Dai, or USDC which is fully backed by the US dollar. Users can also lend Dai to Compound, in which users receive cDai tokens in return. cDai represents the user’s Dai and the interest accrued therefrom.
Does it still make sense to invest in DeFi?
To better answer this question, let us compare DeFi with investment opportunities in traditional finance.
Traditional Assets
Bonds
A bond is a fixed income instrument that represents a loan made by an investor to a borrower. Governments and corporations commonly use bonds to borrow money. Bonds provide investors with a set interest rate on their investment.
Stocks
Stocks, also called “equities,” represent shares of ownership in publicly traded companies. When you buy a stock, you own a tiny share of that company. Although the stock market is volatile in the short term, the stock market has historically outperformed other asset classes in the long run.
Index Funds
An index fund is a type of mutual fund or exchange-traded fund (ETF) with a portfolio constructed to match or track the components of a financial market index, such as the S&P 500. Let’s say you invest $1,000 into an S&P 500 index fund. Your money is distributed to 500 companies according to their weight within the S&P 500. As of September 11th, the 5 largest companies make up more than 20% of the entire S&P 500, which are Apple, Microsoft, Amazon, Facebook, and Alphabet. In other words, $200 of your $1,000 goes to these 5 companies if you invest in an S&P 500 index fund.
Gold
Investors can invest in gold in three ways: you can purchase the actual gold, a mutual fund or ETF that replicates the price of gold, or trade futures and options in the commodities market. Gold has been thought of as an ideal investment in a bear market because gold usually holds its value better in a bear market.
DeFi Assets
Cryptocurrencies
Bitcoin and Ethereum can be thought of as DeFi assets. The most general public has only heard of Bitcoin when they heard about cryptocurrency and blockchain. There are a few exchanges such as Robinhood and index funds such as Bloomberg Galaxy Crypto Index that offer traditional investors to invest in cryptocurrencies with ease.
Loans
Decentralized lending platforms, the best known DeFi use case, provide loans with no intermediaries. DeFi lending protocols enable everyone to earn interest on supplied stable coins and cryptocurrencies. Lending cryptocurrency, also known as stablecoins, provides an alternative to high yield CDs, ETFs, and savings accounts, with relatively higher risk.
Robo Advisor
A robo-advisor is a method to automate the asset allocation of investment. Robo-advisors take the work and worry out of the three most important elements of retirement planning: regular contributions, low fees, and a diversified portfolio. In the traditional financial market, robo-advisors have been exploding in the past few years due to their low fee and convenience.
Does DeFi deserve your attention and a place in your portfolio?
We will use the S&P 500 and Nasdaq 100 as the representatives of the stock market/index fund and S&P U.S. Aggregate Bond Index as the representative of the bond market. We also include Apple and Tesla stocks as a comparison to Etheruem and Bitcoin. We compare the traditional assets against DeFi products including Etherum, Bitcoin, Uniswap (DAI-ETH), and Compound (DAI). Here is the YTD performance of each asset market as of September 10th.
The evidence is pretty clear that DeFi deserves a place in your portfolio. DeFi lending products like Uniswap offered comparable returns against traditional financial assets like the S&P 500 and S&P U.S. Aggregate Bond Index. Gold has provided a solid store of value due to the pandemic and the bear market with a +28.64% return. The soaring return of Ethereum has mostly contributed to the rise of DeFi platforms as most DeFi products are based on Ethereum. Bitcoin also benefits from the soar of DeFi platforms and reached +42.9% YTD returns.
Actually, you should not invest all your money into just one asset class just because it outperforms others during a specific period. The winners and losers during a specific period don’t tell us which asset class is the best in the long term. You should diversify in multiple different asset classes to have sustainable long-term returns.
