The Proliferation of DeFi (Part 1)
As of July 8th, 2019, nearly $646.1 million USD in value is locked in decentralized financial (DeFi) applications. DeFi applications leverage decentralized, permissionless networks to transform legacy financial products (such as loans, derivatives, and other products) issued by banks and other financial institutions into trustless and transparent protocols accessible to anyone with a smartphone and an internet connection.
The DeFi movement coincides perfectly with the grand vision of crypto to build a globally accessible financial system.
Over the past year, DeFi has really come to fruition with more and more applications popping up. Borrowing money, lending out capital for interest, and investing in derivatives has never been possible in a decentralized and permissionless fashion until now. With these ideas in mind, we’ll use this article to take a dive into a few of the leading DeFi lending and exchange applications that have taken lead since this movement began.
Lending
The lending space is currently the largest sector of DeFi. With MakerDao, Compound and Dharma pioneering decentralized lending and borrowing services, they have aggregated hundreds of millions of dollars in value locked within their respective ecosystems.
Maker
MakerDAO is a clear leader in the DeFi space with nearly 1.5M ETH (over 1.41% of the total supply) locked in the system. For those unfamiliar, MakerDAO is a decentralized credit platform which provides a system for a decentralized stablecoin (Dai), collateral loans, and community governance. With this, anyone can leverage Maker and open a Collateralized Debt Position (CDP), lock ETH as collateral, and mint Dai (up to 66% of the collateral’s value) as a debt against the collateral. Open CDPs continuously accrue interest through a stability fee paid in MKR once the debt is repaid. As of now, this fee sits around a 17.5% annualized interest rate. If you’re interested in diving more into the nuances of the Maker ecosystem and the stability fee, we wrote about this in an earlier article.
Currently, only ETH can be used as collateral to mint Dai. However, the Maker Foundation has been making tremendous progress over the past year and is getting closer towards releasing Multi-collateral Dai (MCD) where multiple assets other than ETH can be used to create a CDP and mint new Dai.
Compound
Compound is the second largest DeFi protocol as of writing with 105,000 ETH (0.10% of ETH’s total supply) locked in the system. Compound creates transparent and autonomous money markets that algorithmically sets interest rates based on supply and demand. In other words, Compound allows users to lend or borrow crypto assets against collateral. Compound is permissionless and therefore, anyone can supply assets to Compound’s liquidity pools and earn an interest rate for doing so.
Compound recently released the second version, Compound v2, back in May of 2019. This iteration of the protocol expanded the money markets to other crypto assets. As of now, users can use Compound to lend and borrow:
- ETH
- DAI
- USDC
- BAT
- ZRX
- REP
Like other money market protocols, in order to borrow or lend crypto assets you have to put up some form of collateral. With Compound, users can borrow up to 50–75% of their collateral’s value depending on the underlying asset.
Dharma
Dharma is protocol on Ethereum for tokenized peer-to-peer debt assets. Dharma is permissionless and therefore anyone can issue or underwrite debt agreements. The unique aspect about Dharma, unlike other lending platforms, is that users can borrow uncollateralized loans. This is done by leveraging underwriters in the system who are responsible for dispersing the loan and assessing the borrower’s credit worthiness and service debt.
Loans on Dharma are subject to a 28-day loan term. As it launched in April 2019, Dharma is rather new to the DeFi space as but has already garnered around $25M in total locked value. Moreover, Dharma has been rather quick to release more financials products such as Dharma Lever — a trustless service for accessing margin in high volume from anywhere in the world.
With Dharma Lever, prospective borrowers can submit a loan order with collateral to the Dharma smart contract. Similar to Maker and other collateralized debt positions, Dharma Lever requires 150% collateralization for loans. If a loan becomes undercollateralized, designated actors can liquidate.
Decentralized Exchanges
Back in 2017, investors looking to trade on a decentralized exchange had to rely on EtherDelta (now ForkDelta) which was commonly accepted as having one of the worst exchange UI/UXs the crypto community will likely ever see. Regardless, the notion that EtherDelta provided a completely permissionless mechanism for listing and exchanging tokens on Ethereum still drew millions of dollars in daily volume throughout 2017.
Uniswap
Now, we have Uniswap — a fully decentralized exchange protocol on Ethereum which launched in November of 2018. Similar to EtherDelta, Uniswap provides a trustless and permissionless mechanism for exchanging and listing tokens within the Ethereum ecosystem. This allows people to easily swap ETH for any ERC20 tokens and vice versa. Moreover, Uniswap utilizes liquidity pools that allow anyone to create a market and supply with it an equal value of ETH and the respective ERC20 token. Creators of these pairs earn a fee each time the market is used.
Unlike most exchanges, Uniswap does not have a native token and therefore, liquidity providers earn the fees dominated in the assets within their respective market.
Since launching in November of 2018, Uniswap has garnered nearly $20M in asset value locked within the protocol and therefore, $20M in liquidity. MakerDAO’s MKR is dominating the liquidity standings on Uniswap with a substantial $7.4M locked in the protocol. After MKR is WETH, an ERC20 token equivalent of Ethereum, with $5,3M in locked value followed by DAI, MakerDAO’s stablecoin, with $2.1M in liquidity.
https://twitter.com/UniswapExchange/status/1143905508140736513
As the crypto industry continues to grow, we’re excited to see which assets will leverage Uniswap’s permissionless nature to build liquidity for an asset rather than relying on centralized exchanges and paying exorbitant listing fees.
Republic Protocol
In order for DeFi to continue to grow, it’s important that each of these applications have sufficient liquidity to eventually compete with centralized exchange spreads such as those on Binance. Ren Project aims to solve liquidity gaps by providing interoperable exchanges between any blockchains regardless of the underlying protocol. Furthermore, all transactions are anonymous thanks to zero-knowledge proofs and secret scripts.
“Our vision for Ren is a private and interoperable liquidity layer for the decentralized world. Powering the free movement of value between blockchains in zero-knowledge.”
Ren is currently developing a new virtual machine, RenVM that will allow any two tokens to be privately and instantaneously swapped for minimal transaction fees. All fees paid using Ren are dynamic (minimum fee of 0.1%) when exchanging between two different blockchains and Dai based when using general purpose scripts.
Ren Project is gearing up to release their testnet in the coming months, highlighted by their unique Tendermint-based consensus algorithm, Hyperdrive. In the future, the RenVM SDK will serve as a ‘plug-in’ for DeFi by allowing any application to incorporate interoperability capabilities into existing smart contracts.
Conclusion
The applications described above provide significant opportunities for individuals looking to control their own financial freedom outside of traditional institutions. Most importantly, DeFi lending and exchange platforms have provided the first wave of trustless financial applications for a decentralized future.
Since we’ve taken a look at some of the more basic concepts in DeFi, our next article will take a deeper look at more complex uses such as derivatives and new forms of tokenized assets.
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Writers: Lucas Campbell — https://twitter.com/0x_Lucas
Cooper Turley — https://twitter.com/Cooopahtroopa
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