Decentralized Finance Part 2: Pushing The Lending Envelope
>> This article is for informational purposes only and is not financial advice. The information does not constitute investment advice or an offer to invest.
Part 1 discussed in-depth the draw of decentralized finance over centralized finance, touched on the potential future of open lending protocols and the drawbacks of current centralized systems. In a recent report by Bloqboard comparing the most prominent open lending protocols, it was found that an estimated $251.4 million originated from open lending in 2018, an astonishing amount expected to grow with the rise of fintech as an industry.
Several noteworthy contributors to this amount are currently at market, from Compound to Dharma, MakerDAO to dYdX and more. Some of these protocols have been advancing the decentralized finance industry since 2015. This is what needs to be known about these protocols and the deep potential they hold for finance as it is currently known:
Compound
Compound is an open protocol created specifically to offer algorithmic and efficient Money Markets based on the Ethereum blockchain. Those who use Compound and its integrated decentralized applications (dApps) can earn interest on Ether and other tokens, or borrow digital assets through Compound to use for other investment purposes.
As an open lending protocol, Compound does not grant loans directly. Instead, Compound users add assets to an allocated liquidity pool which is set aside for lending purposes, and from which funds are instantly available for withdrawal by lenders. With Compound, the loan amount available is based on the borrower’s own collateral which they provide to the protocol in order to gain access to these loans. The protocol also analyzes and sets interest rates, based on the current supply and demand within each money market.
Dharma
Dharma is another decentralized finance potential game-changer, building globally-accessible lending products by using tokenized debt through the Ethereum Mainnet. Dharma currently supports a multitude of lending protocols through their platform, but they intend to add support for the borrowing and lending of any digital asset.
Loans granted through Dharma are all denominated in USD, which grants both the borrowers and lenders some protection from the volatility risk associated with most cryptocurrencies.
Similar to the loan operations of Compound, all Dharma loans are decentralized. Dharma does not provide the funds for loans but rather provides the tools through which Dharma users can access the funds. At the time of writing, Dharma is the only entity that is authorized to decide a borrower’s creditworthiness and approve a loan.
MakerDAO
Maker wears many hats. It’s a combination of a stablecoin, collateral loan platform, and decentralized administration all in one. The Maker Platform consists of two coins: Makercoin (ticker MKR) and Dai (ticker DAI). Dai is the stablecoin version, which is valued at 1 USD, similar to the stablecoin Tether. Dai also cannot be mined, and has a total supply of 87,969,609.
Makercoin is the other digital asset on offer, mainly with the purpose of a utility and governance token used specifically on the Maker Platform. The Dai stablecoin is more suitable for payments, savings, or putting up collateral and was the first decentralized stablecoin to be developed on the Ethereum blockchain.
With Maker, anyone can leverage their Ethereum assets to generate Dai, and MKR holders can prevent risky borrowing behavior as a community which can prevent large scale issues through the ability to trigger an emergency shutdown and other security measures.
dYdX
dYdX is a lending protocol designed for decentralized margin trading and derivatives. These derivatives can help traders minimize risk, develop in new ways, and provide some shelter from market volatility. dYdX allows users to borrow money from one another through digital assets without the need of a broker. Lenders can provide loans for margin trades by signing a message that has information about the loan product such as the value, which tokens are used, and the interest rate.
dYdX uses the asset-backed Dai stablecoins from MakerDAO as a quote currency for Margin Tokens. This is mostly due to the ease of margin exposure that is available through the trading of an ERC20-based asset. dYdX combines automating deals through Ethereum smart contracts with various financial products such as interest-generating loans, short sells, or leveraged long positions.
Successful Scaling and the Lightning Network
For decentralized finance systems and open lending protocols to succeed, scaling will be a key issue to solve. At present, centralized financing institutions process large amounts of data and payments per day, and these networks have yet to reach these numbers. One scaling solution is the Lightning Network, a second “layer” which operates on top of a blockchain-based cryptocurrency such as Bitcoin or Ethereum. The Lightning Network works by opening a payment channel through committing a funding transaction to the relevant base blockchain, which lets people instantaneously send or receive payments and minimize transaction fees. This private channel also allows participants to transfer money to each other without having to make all their transactions public.
Successful implementation of the Lightning Network will lead to faster transaction times, and process an estimated 1 million transactions per second. This network recently made the news due to the extension Tippin which adds the option to tip Twitter users with the help of Lightning Network.
These open protocols are contributing to the popularity and usability of decentralized finance in exciting ways, and it’s reflecting in their financial growth. From providing loans to offering protection from volatility in trading and increasing scaling, the benefits of these protocols could far outweigh the disadvantages.
These developments are forming the building blocks of an industry which should evolve to meet and exceed expectations. Decentralized finance is especially seen as a viable option by many millennials, who grew up with the internet and may distrust approaches used by the traditional finance industry.
About the Author: Kirill Bensonoff is a serial entrepreneur with multiple exits, blockchain investor and advisor. He’s also the host of the Boston DLT Meetup, founder of the Boston Blockchain Angels, producer and host of The Exchange with KB podcast and leads the Blockchain + AI Rising Angel.co syndicate. Learn more by visiting www.kirillbensonoff.com and follow him on Twitter @prankstr25.
Disclaimer: Virtual currency is not legal tender, is not backed by the government, and accounts and value balances are not subject to consumer protections. This article is for informational purposes only, and is not financial advice. The information does not constitute investment advice or an offer to invest.
