By Ibrahim Alkurd, CEO of New Mine, a blockchain mining hardware and software company, and a partner at Lavaliere Capital, a digital asset hedge fund.
The cryptocurrency market is currently seeing a massive decentralized finance (DeFi) hype that can be likened to the initial coin offering (ICO) hype of 2017. DeFi creates decentralized financial instruments that are separate from traditional centralized institutions. In theory, DeFi instruments can issue things like mortgages and insurance without needing to go through a bank. The contracts would be executed through codes. This reduces the cost of financial products and opens the financial system to many more users. It’s still very early stages for DeFi, and although some great progress has happened recently, we’ve yet to see the long-term implications of it.
Aggregate trading volume on decentralized exchanges rose from $1.52 billion in June to $4.32 billion in July. Alongside this, many of the DeFi tokens have seen astronomical price growth recently. Many of the DeFi protocols are running on Ethereum (ETH), and the ETH network has seen large increases in transaction fees. (Full disclosure: I own Ethereum and Tether currencies.) This resulted in over 40% of Ethereum mining revenue in August coming from fees.
All of this provides great opportunities for individuals, companies and investors in the cryptocurrency sector. However, it does come with its risks, and it can be a very difficult area to navigate. Here are some of the different categories of DeFi projects and things to be on the lookout for.
Uniswap, a decentralized exchange running on the Ethereum blockchain, is currently the most popular by volume. We’ve also seen some big players, such as Binance, launch their own decentralized exchanges (DEXs). DEXs have peer-to-peer transactions of digital assets between two parties on the blockchain without the involvement of any third parties. This lets you trade tokens without needing to deposit them on a centralized exchange.
Many decentralized exchanges claim to be noncustodial and decentralized, but unfortunately, that is not always the case. Due to their early and emerging nature, it’s best to do thorough research before deciding which DEXs to use.
Borrowing And Lending
Developers have built borrowing and lending protocols on the blockchain. One of the most popular forms of this form of DeFi has been Compound Finance. Compound allows you to lend or borrow cryptocurrency and pays cryptocurrency yields to the lender. Borrowers and lenders are automatically matched, and everything is settled through smart contracts. This cuts out the need for intermediaries and allows lenders to earn higher returns than through utilizing traditional methods.
Stablecoins are tokens that are issued on the blockchain and are designed to retain a specific value. This is usually done through pegging the value of the token to a fiat currency, such as the U.S. dollar. Tether and USDC are two very popular stablecoins.
I’ve found stablecoins to be incredibly useful for transferring money instantly without needing to worry about being exposed to the volatility of cryptocurrency. One of the issues of stablecoins like Tether and USDC is that they have a centralized component to them, and this presents counterparty risk. To reduce your risk, aim to stick to the most popular stablecoins and to keep the stablecoins off exchanges, in cold wallets, as much as possible.
We also have crypto-collateralized stablecoins. Maker is a stablecoin project where each coin (called DAI) is pegged to the U.S. dollar and has collateral in the form of cryptocurrency. To date, stablecoins such as Tether and USDC have proven to be more popular than DAI, but this may change in the future.
Beyond this, there have been DeFi applications in synthetic assets, prediction markets and investment management platforms. It can be easy to get carried away with the hype, but you need to take extra care when navigating this market. Despite the huge potential of DeFi, remember that the majority of these protocols are in very early stages, and most are likely to fail.