New to DeFi

Decentralized Finance (DeFi)

DeFi is a burgeoning field in the cyrptocurrency space aiming at recreating existing financial products in a decentralized manner. The field of DeFi has been heralded as the mechanism to increase inclusion and level the playing field in financial markets. This is accomplished by lowering the capital barriers to entry; however, the knowledge gap is still rather large making DeFi a difficult field for retail users to get involved with. The advent of pooling assets for liquidity and lending has led to ecosystems like Ethereum, Binance Smart Chain, and several others seeing significant rise in their network valuations and usage. Asset pools do not require a minimum amount of capital to put one’s assets to work and start earning yield, which is often compounded much quicker than in traditional finance. 

An explosion of growth occurred in the DeFi space during the year of 2020, which saw many shortcomings pop up in regards to the short comings of our traditional financial market structure. Much of this was brought on by the global pandemic and subsequent shutdowns of economies, which pushed businesses of all industries and governments to find new ways to work in a growing digital landscape. DeFi took hold as yield options in traditional markets were becoming non-existent and it can be accessed from anywhere in the globe at any time. In fact, DeFi has grown exponentially from 2019 to present, which has led to increased focus around smart contract functionality on layer 1 blockchains. We now even see blockchains like Dogecoin and the XRP Ledger are looking to implement smart contracts in their own specific way to embrace the value flow to decentralized financial markets.

Smart contracts are essentially programs that can compute advanced business logic functionality. They can take into account internal and external data via oracles as the criteria that initiates certain processes via these smart contracts. As smart contracts are more complex than some of the more basic record keeping activities of layer 1 blockchains, they can require more computational power, which can lead to decreased throughput and increased fees if a network becomes too congested. The meteoric rise in on-chain activity on Ethereum has proven the use case of DeFi, but also shown that this new industry is far from having been perfected. Unfortunately, for newer entrants into the blockchain space, this means that the only expectation should be further change on how public, decentralized ledgers utilize and enact DeFi across their respective platforms. 

Luckily, as more value flow into DeFi networks, then more industry players will be involved helping to lower the knowledge barriers to entry through increased automation and user-friendly platforms. This is being accomplished through the creation of automated yield aggregators that will deploy user assets in pre-defined ways based on risk tolerance and yield expectations. Additionally, CeFi providers are offering all in one solutions for staking assets with them, where they handle the work of deploying staked assets in return for a fixed interest rate to the user. However, one can assume that the CeFi firms are taking a solid cut off the top. This does make earning yield on a user’s assets easier, but can limit the upsides of participating in DeFi. It also introduces counterparty risk as the CeFi firms are custodying user assets. 

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