When will we see a DeFi Bank?
DeFi platforms are quickly becoming one of the most used Dapps in the blockchain ecosystem. The more people discover alternative investment strategies the more popular the DeFi movement will become. The potential for decentralised finance to compete against traditional banks is immense. There are many services that can be disrupted. Hopefully In the future you won’t need a bank to act as the intermediary for all your investment needs. Alternatives are coming, especially for the unbanked.
Facebook and Libra will be facing an uphill battle with regulators as it aims to create its own cryptocurrency to be used within a closed network with other large corporations as participants. I have no personal view that they should fail, in fact the creation of Libra legitimises the DeFi concept as a viable alternative to traditional banking. The biggest organisations in the world are now starting to realise the importance that Cryptocurrency and DeFi will play in the world.
Facebook was the first of the FAANG’s to jump on the Crypto bandwagon but Apple already has Apple Pay. How long before they see that it makes sense to integrate Blockchain concepts on their payments platform?
Facebook deserves support from the crypto community as it is going to be doing a lot of the dirty work in getting regulators on board. Whether it be by forcing clarity or changing existing laws. Either way we will get a set of guidelines to work by that will benefit the rest of the community.
If Libra, whatever their intentions may be never sees the light of day things will still be bright. There are many blockchain projects working to solve the same problem of finance for the unbanked.
The Current Banking Services
People in developed nations will most likely have a bank account that they use for their simple everyday financial needs. The common retail banking services include such things as:
Transactional Bank Accounts — Your everyday transactional account which typically earns you low interest. These days it will most likely be under 2% APR.
Higher Interest Term Deposit Accounts- Where you lock in funds for a fixed term and rate. Usually giving you a higher interest rate than your transactional bank account. Will come with penalty fees if breaking out early. The banks then use your funds for fractional banking.
Unsecured Borrowing- Smaller sized loans called Personal Loans that rely on your credit history. You don’t require collateral to secure funding but default risk for the bank is mitigated through higher charged interest.
Collateralised Loans- Larger loans such as Mortgages and Margin Lending. You will need to provide collateral to secure funding. If you default on repayments the bank will seize and sell your assets.
Trading Accounts- To trade various equities and derivatives markets. You may be charged trading, custody or management fees.
Insurance- Where you pay a premium for various types of insurance in the instances where things do not go as planned. Could be Life, Health, Home and Contents Insurance for example.
International Transfers- Exchanging and transferring various fiat cross borders.
Credit Cards- A plastic card that utilises either MasterCard or the Visa network to let you magically buy things. Merchants get charged about 3% which is most likely passed onto the consumer. You may also be charged annual membership fees. Reward programs could be tied to the card allowing you to build points and redeem awards.
Retirement Accounts- Regular contribution accounts that come with very attractive tax benefits. These funds are usually locked up until you retire around the age of 65.
Essentially at its simplest a Bank acts as an intermediary between Depositors and Lenders. They are heavily regulated by Authorities and Governments so that some kind of trust is established. For that trust you pay bank fees.
But things are changing with Blockchains and DeFi applications. Now trust can be established in computer code.
What are the current DeFi applications and what do they offer?
The first generation DeFi applications are mimicking the early concepts of how Banks were used, namely facilitating services between Depositors and Borrowers. Current DeFi’s fall into 2 use cases: Lending and DEX (Decentralised exchanges facilitating swapping one token for another).
There are still huge opportunities in the DeFi area to tap into the traditional offerings that banks have.
Looking at Lending which is proving to becoming more and more popular. FUM is growing nicely over the past year as can be seen in this graph from defipulse.com. As of July 2019, locked in crypto is valued at over $430 million.
As the DeFi’s battle it out to grab deposits and FUM they will need to keep innovating to attract new users.
The popular Lending Dapps are…
A DeFi platform that allows for the borrowing, lending and leverage trading of DAI, USDC and ETH. The great thing about DyDx is that your assets are earning interest at all times while on the platform. There is no separation between a trading and lending account. You could lend out your DAI for a good interest rate and then trade for ETH quite easily if you see a dip in the market. DyDx also lets you go Long or Short an asset with leverage.
What is reassuring is that DyDx also maintains an insurance fund in case a black swan event causes lenders to suffer losses. I would not recommend lending on any platform that does not have some kind of insurance policy for lenders. Even if you take a slightly lower interest rate it will be worth it.
When making trades on DyDx there are no transaction fees but you do have to pay Ethereum Gas fees. The Gas fee are the same regardless of the size of your trade so small trades might not be worthwhile.
Has a wide range of cryptocurrencies that can currently earn very high interest rates. You can also borrow and margin trade on NUO. They are integrated with Uniswap and Kyber to fulfil trade orders which is a very cool way to get liquidity.
What separates NUO is that interest is not paid out at a set schedule, rather interest is earned whenever Borrowers pay back their loans. You might go a few days without earning any interest on your deposit but then get a big lump sum payment randomly. If you are a patient lender it can work out in your favour.
NUO also has fiat on ramp for US customers. If you have a debit card you can buy up to $40 of stablecoins a day.
With other DeFi’s there are network fees whenever you want to make a transaction but with NUO they take care of most of the fees. You will however have to pay Gas fees to deposit crypto to NUO from Metamask. Creating reserves, stopping and withdrawing your crypto on NUO is then without fees. This is a feature they need some more credit for!
There is no insurance fund and the platform has known to give negative interest to some users. This happened when there was a flash crash on LINK and the platform was not able to liquidate fast enough due to network congestion. The team has addressed the issue and made changes but I would still champion for an insurance fund. Hackers are always on the lookout for creative ways to snatch crypto. Protection for depositors cannot be guaranteed by code.
Very nice and intuitive UI makes Dharma a popular choice for many. They only offer fixed terms for lending and borrowing currently. You also need to wait for your offer to be matched with a borrower which can take 48 hrs to even a few days. Once matched your funds are locked for up to 90 days depending if it gets paid back early or not. If you are a borrower and decide to pay back early you will need to pay back the whole term interest amount which kinda sux for you.
Last month they introduced instant earnings for deposits up to $5000. That however seems to be gone when checking today without any warning or announcement. Hmmm I wonder what happened there?
Compound is a pioneer in the DeFi lending space and therefore has built up quite a following. Also has a nice clean simple UI which is easy to use.
They recently introduced Wrapped BTC which is great to see. The Bitcoin protocol doesn’t allow for smart contracts so there are no DeFi applications on Bitcoin which is a shame. Wrapped BTC is the next best thing that allows for non custodial lending of Bitcoin.
I find that DyDx and Compound have similar lending features however Compound lacks the trading ability that DyDx offers. DyDx came after Compound so has been able to observe and build on top of the first generation DeFi’s. Competition is going to make things very interesting going forward. Can’t wait to see what comes next!
The original DeFi application whereby you can lock up your ETH to create a collateralised debt position (CDP) to generate DAI. DAI is then able to be used across the other DeFi’s in turn. To maintain the peg with the USD the APR has to be constantly adjusted by voting. Currently it’s about 20% APR so if you want some DAI there are better options out there.
There are some limitations self imposed by Maker such as a 100 million DAI supply cap. Once the peg has shown that it can maintain itself then i’m sure the supply will be raised.
Another exciting development is that Multi collateral DAI (MCD)is in the works which will allow us to lock up other assets besides ETH to create DAI.
What are we seeing in DEX?
Taking a look at Bancor, Kyberswap and Uniswap there aren’t that many differences in functionality besides the pooling model that Uniswap offers. All 3 do not have order books so you can trade without the need for a counterparty. Personally I find slippage is an issue so I don’t trade on these platforms. I still do most of my trading on centralised exchanges for this reason.
With Uniswap pooling you contribute liquidity to the exchange by adding trading pairs. When the pairs are traded you earn a share of the fees from that pool. It’s another great way to earn some passive income if you are hodling those anyways.
IDEX is a DEX that currently has the most volume and users per day. It has order books and lets you place limit and market trades. There doesn’t seem to be much liquidity for most pairs so slippage is an issue. If you care about non custodial exchanges and have AML/KYC concerns then you might want to use it.
Where are the Derivatives DeFi’s?
Augur prediction markets platform allows you to bet on a future outcome of basically anything. This includes price predictions of cryptocurrencies which sounds like an Options trading platform to me. The platform is quite hard to use but the team is working on a v2 so I am hoping things become more intuitive and user friendly.
I have been waiting for a DeFi options trading platform with high liquidity and am hoping that Augur or some other Dapp will allow the simulation of Puts and Call Options. Introducing different ways for traders to make extra income on long and short strategies.
What would a DeFi Bank look like?
The landscape for the first generation Dapps out have combinations of some of these features:
- Margin/Leverage Trading
- Prediction Markets
But what I really want to see is a Dapp that combines all the great features from each into one platform. If you can entice users to deposit their crypto into the platform other opportunities for more complicated features become available.
How would this look platform look? It would offer all of these functions:
Provide flexible options for:
- Variable rate accounts with no minimum deposits and lock up periods
- Ability to offer Fixed rates and term lengths which can then be taken up by borrowers in a marketplace.
- Advanced order features such as Stop loss, Limit and Market orders.
- Zero trading fees besides Gas fees. Gas fees on Ethereum are too high IMO and is a huge barrier to more transactions being initiated on DeFi’s. Gas prices change depending on network load. I have paid ~$0.20 many times to interact with smart contracts. Ethereum 2.0 cannot come fast enough.
- Benefits for high volume traders. Exchanges such as Coinbase reward traders if they trade a certain amount in the past 30 days in the form of reduced fees. If you could get a bonus interest rate on your deposits by trading more would you use a DeFi over a decentralised exchange? Hell yeah I would trade more and even deposit more crypto on the platform!
- Tap into the Liquidity pools of other DEX platforms.
4. Margin/Leverage Trading
- Collateral used for leverage trades also earns interest.
- LVR assigned to cryptocurrencies.
5. Option Derivatives
- Prediction marketplace that simulates the buying and selling of Puts and Calls
- Call options allow to allow a holder to buy an asset at a stated price within a specific timeframe. Put options allow the holder to sell the asset at a stated price within a specific timeframe.
Dashboard views and downloadable statements on performance and holdings.
- Tracking portfolio performance over time
- Show interest paid and earned
7. More Assets
- A wider choice of Cryptocurrencies. People still love their shitcoins!
8. Insurance Fund
- Percentage of interest accrued set aside as an insurance fund in the instance of black swan event. Losses by lenders will be made whole by the fund.
It is hard battle for a DEX to compete against centralised exchanges such as Coinbase and Binance but where DeFi could carve out market share is to build out additional non custodial features that give users peace of mind. There’s a strong phrase in crypto after all that goes “Not your keys, not your crypto”.