Crypto’s Next Big Thing: Decentralized Finance Takes On Wall Street
Traditional financial systems. Advocates say it has the potential to make the current financial system more efficient, accessible and faster, were talking about decentralized finance or defy a financial system without banks, at least in the traditional sense, without a middleman executing your transactions. Instead, you have smart contracts or computer code that automates the process. Anything you would go to a traditional financial institution for like high yield savings, borrowing, lending trading, investing those are all things that can be found in d5, decentralized finance has captured only five percent of the crypto space, but it has attracted massive growth. There is 93 billion dollars worth of defy assets in the crypto market as of june 2021 up from 4 billion just 3 years ago. The really massive creative power of defy is how quickly developers can iterate and build financial applications that was really never possible in finance. The pace of d5 has slowed since the summer of 2020 and regulatory scrutiny from capitol hill has spiked over fears of cryptos checkered past heres, how decentralized finance works and why lawmakers and the financial establishment are keeping an eye on it. Decentralized, finance or defy can be described as an ecosystem of financial applications and projects built on top of blockchain technology. The whole point is that theyre decentralized, which means that whoever youre transacting with youre doing it directly with them, rather than through a traditional financial institution like a bank or an exchange or a brokerage. So, rather than having one of those, traditional entities mediate the transaction, its mediated by smart contracts, which are self executing contracts.
According to the code, which you know includes the details of the agreement with you and the other person most defy, projects are built on ethereum because it was one of the first programmable blockchains that can handle smart contracts. Most d5 protocols are governed by their own communities or whats known as a decentralized autonomous organization dao. For short, only the members whove invested in an individual projects token get to vote on the protocols future. It removes the control from one person the crypto industry was born in reaction to the 2008 financial crisis. Defys goals stem from that and give users control and visibility of their own money without a third party. A mainstream user can either decide to go directly and use these protocols or might be indirectly using by using some of the traditional financial intermediaries at the same time. But the main difference here is that the user will have a choice that you either can rely on. Someone or you can manage your own cryptographic assets and your keys by yourself, and it brings kind of like the finance as a human right for the users. If we start to see defy actually um, you know impacting things like making it easier for small businesses to access credit at a larger scale, easier for people to access mortgages or other kinds of examples of providing some sort of real benefit. Then itll actually start to be easier to understand, sort of how it works and the point of it.
During the summer of 2020 interest and decentralized finance began picking up the total value locked in the space grew from 7.8 billion on june 20th, 2020 to 19.4 billion. On september 21st 2020, the total value locked is a metric used to assess how much crypto is committed to a smart contract of a project since 2018 to 2020, we saw the rise of automated market makers, which, for the first time, bootstrap liquidity and allowed these decentralized Exchanges to become much more liquid when that work than they were at the same time, we also saw an increased development activity on the user front end and made these applications much easier to use. Most d5 projects or protocols can be categorized into four main buckets decentralized exchanges, lending platforms, acid management and derivatives, decentralized exchanges and leading platforms were the areas that grew the most during d5 summer, so were going to highlight those decentralized exchanges or dexes are cryptocurrency exchanges that Allow users to trade without giving control their funds to an intermediary. One of the leading dexes is uniswap an automated market maker protocol built on ethereum that has risen due to its liquidity offerings. So a lot of crypto assets try to do everything. Uniswap does one thing: it tries to compete with coinbase and its interesting, because there is massive trading volume on unispot, its trading 40 or 50 billion dollars of crypto per month, its generating hundreds of millions of dollars of fees. The developer of unispot uniswap labs is currently under investigation by the securities and exchange commission.
Decentralized finance allows anyone to borrow and line cryptocurrency users can earn interest when they loan their assets. They can also borrow other cryptocurrencies by using their current funds as collateral. Stani. Kolechov is the founder of ave one of the first and leading d5 lending protocols cryptographic assets. These states can be ethereum, so called stable points. Our protocol allows actually to supply this kind of assets into the protocol, and then there are other participants that are taking those funds out of the protocol against a collateral which means that it generates yield for the suppliers, its a place where you can grow your cryptographic. Assets in form of interest yield defy continues to expand and you go from 100 billion to 500 billion 600 billion. The banks are going to have to start realizing, hey theres, actual real competition here, as assets are flowing into the d5 ecosystem and away from us, Music, decentralized finance has attracted wall, street veterans and developers alike. It has pushed cryptos potential from being simply a digital currency. To a software tool that can be used to improve the antiquated traditional financial system, thanks to the programmable qualities of ethereum, the thing about crypto that gets traditional financial people so excited is that as a technology, it solves all that it allows money to move onto the Internet, it allows you to program money, it creates digital property rights, it introduces efficiency and creates the potential to disrupt an industry. That is one of the least efficient in the world.
Investors have been on the hunt for yield, as interest rates remain. Low. D5 protocols have offered opportunities to chase yield through a method known as staking a lot of these assets. You can stake and you receive a reward, and that reward gives that token some value or some aspect to it, that you can then kind of derive what that asset should kind of be worth. There is almost like an income that can be generated from staking these rewards uh from mining it or some other process. You know, on the institutional side, a lot of the ones that youre seeing start to jump in are the hedge funds. They are able to be a lot riskier, so theyre able to experiment more one of the key drivers is that there is a lot of need for leverage. So many of these uh protocols. What what is happening is that you are able to unlock capital and to unlock capital when you deposit lets, say cryptographic assets into the other protocol, youre borrowing cash, which means that you need cryptographic stable points. And that means that the yield on that cash and the cost is going higher, and what usually is the typical use case is that you take the cash and you buy more of that particular asset, and you are leveraged position. Decentralized finance is like the electric car in the automobile industry, so you know everyone kind of knows that thats the future, but car companies will still make cars that will just make electric cars instead.
Regulatory concerns, though, continue to hand over the entire cryptocurrency industry and could stunt defys growth. You know theres not a lot of kyc implementation that could even be collected, because a lot of this is just a decentralized open source system. Theres not really an account thats collecting information, so some of the information sharing agreements and stuff like that, you see in traditional markets its hard to replicate 100 into d5. So what needs to happen is probably uh a more nuanced model and a new regulatory framework. Now i think we are starting to see some of that. There could be some cases where this infringes on defy and it could hurt some defy assets, but it could also be a case where you establish a more mature d5 ecosystem, where you actually see more growth. Defy comes with a huge risk because of the lack of regulation, investors and users have no protection or insurance if they lose their cryptocurrency in a protocol or through loaning assets to another user. The risk is well known, but with the huge risk comes huge gains for traders. The crypto markets remain volatile in march 2020, a sudden 30 price drop in ether triggered chaos in the default space. Some investors lost all their collaterals in protocols like maker, dao, meeker dao. Once considered the d5 poster child has been blamed for not fully representing the risk to investors. Roon christensen, the co founder of maker dow says the protocol had been prepared for this event and was able to recover from the event, but it was a case that the system hadnt seen before it wasnt a disaster, but the mega protocol.
The whole space was able to to recover from it. I mean pretty much instantly afterwards, the maker protocol and the community. They then, just like, were able to analyze the situation and then make a whole bunch of adjustments and upgrades to to you know deal with future situations like that defy summer. Didnt fix these issues and arguably has led to the rise of gambling protocols in some parts of the space. Still optimists in the space say, maker dows rebound proves d5 strength and room to improve. You can really see this sort of evolutionary potential of decentralized organizations, because any time there is a loss of defeat, i guess you can say becomes a really important learning opportunity to then overcome that problem and create resilience. It will be some time before.