Keld van Schreven is the Managing Director and Co-Founder of KR1 plc, and the London listed cryptoasset and blockchain investment company. This summer has seen the beginning of a fresh plug cycle in technology and finance.
The campaign is called DeFi, which is for Decentralized Finance, and the good news is that you can get connected and join it too. DeFi began with the Big Bang in 2008 when the Bitcoin (BTC) white paper was published. Consequently, new DeFi projects such as Melonport, the decentralized asset management project, started launching from 2017.
The prevailing DeFi boom, which at present has over USD 4.5bn locked into it and growing fast (since I started this post USD 2bn in assets have been added!), is also directly down to Bitcoin, which we will explain later in this piece.
There is typically too much center on crypto prices in the media, which can be very distracting, but higher price leads to greater concentration, and the DeFi surge in volume is drawing a lot of interest.
This fledgling DeFi movement has a tiny community currently of around a few thousand people echoing the early Initial Coin Offering (ICO) crowd who were evangelists for the technology, and not focused on speculation.
In financial terms, the DeFi boom will possibly eclipse the ICO boom of 2017/2018.
The enthusiasm throughout DeFi is with the selection of blockchain technology and its impact on new financial services. And these new DeFi projects are not just speculation, and they are generating huge cash flows already. DeFi is taking the core decentralization concept of Bitcoin, the radical financial project that started it all and pushing it to the next level. This DeFi movement is just the next phase of blockchain technology, finding a ‘protocol market’ fit, and we will likely see many more.
DeFi, like the ICO, promises new dawn of financial freedom for all involved, but this time it’s got real use. What is DeFi? DeFi is a set of blockchain-based financial services and applications focused around insurance, banking, investing, alternative savings, and asset management, to name a few and is intended to augment or replace the currently existing financial system using decentralized technology.
There is also a new meme in Yield Farming where borrowers can lend again the assets out and ‘farm’ the yields. Devi’s roots are very much fixed in that ICO revolution, which was that anyone could participate in tech investing from anywhere in the world. Silicon Valley was so over!
In spite of the fact that a small volume of ICOs remains today, ICO’s have fallen out of favor because of abuse by speculators and scammers. DeFi offers a more sustainable version of the ICO movement. One that is less about speculation and more about real involvement and utility.
Eventually, DeFi has improved risk and reward dynamics for participants, and on top of this, greater regulatory scrutiny has emerged in the past couple of years.
Most DeFi projects are fairly simple to use, and if you want to explore them further, they have layers of financial complexity, but the entry points are super simple. All you need is some crypto and a crypto wallet.
Most beautifully for members, the compensations are in the form of sought after tokens in the platforms themselves. These tokens have governance, financial and technical aspects to them. Governance in the form of voting power, finances with fee distribution, and technical insofar as they need active engagement.
An example of an area of DeFi is the Decentralized Exchange or DEX, which aims to replace the centralized exchange. The earlier centralized exchanges were riddled with hacks, corruption, and a lack of trust. Decentralization solves this trust issue, so you keep control of your assets and can trade in a more secure environment. Individuals can supply their crypto assets into these new trusted DEX pools and earn rewards in these new DEX exchange tokens. The possible results from these DeFi token rewards can be outstanding.
Notwithstanding, it should be perceived that there are probably better returns for just investing, holding, and selling than lending, but it suits a different requirement and risk appetite. Most DeFi services need digital assets as collateral to earn a return, but that collateral is at risk.
There are other uncertainties connected of course, such as the project being hacked with funds being stolen, and the assets decreasing in value against each other if one spike in value, but nothing comes without risk and just as your bank deposit is insured against bank heists, there are insurance solutions within DeFi to protect your digital assets.
One of the main drivers of this boom is that BTC is moving into the Ethereum (ETH) blockchain, spawning all these new DeFi services. It makes Bitcoin and Ethereum more interconnected than ever.
It feels like Bitcoin missed the whole innovation cycle that it partially promised. This huge inflow of BTC into Ethereum is creating new liquidity opportunities for Bitcoin as, until now, it has been trapped as a liquid asset. It is just used as a store of value or payment instrument.
This unlocking of Bitcoin is in the form of wrapped Bitcoin such as wBTC or the more decentralized renBTC and tBTC to come, and it all flows into Ethereum.
This may switch as other blockchains launches such as Polkadot (DOT) or Dfinity (DFN). Combine this flow of BTC to Ethereum with new, more trusted DEXs now, after years of development, ready for primetime. DEX had USD 1.51 billion of transactions in June 2020, 70% more than in May, and a 46% increase on the all-time high in March.
The DEX volume still only represents 2.1% of the volume on centralized exchanges, but the needle is moving fast. In May it was just 0.84%! Without this confluence of rising DEX volume, hundreds of millions of dollars’ worth of BTC flowing to Ethereum, and entrepreneurs building on Ethereum, the DeFi boom would not be happening. Bitcoin is finally being unlocked into a whole new load of innovative services via Ethereum.
Presently, the darlings of DeFi are projects such as Compound (COMP) and Balancer (BAL), some new unicorns that touched Implied Network Valuations of nearly a billion dollars. Many more will follow and hope to emulate unicorn status with token releases such as Uniswap, Curve, Sythentix (SNX), Nexus Mutual (NXM), and Vega, to name a few.
Nearly all of these DeFi projects are built on Ethereum, the biggest public blockchain, but other blockchains will compete in this DeFi boom. Many of the Ethereum competitors are in the final stages of being built, such as Polkadot, Dfinity, Tezos (XTZ), and Cosmos (ATOM). These other chains exist because Ethereum hasn’t solved its scaling issues.
They offer higher transaction throughput and interchain interoperability, which Ethereum doesn’t. These blockchains are like expanding universes; each will have their expansion and growth to large economic sizes.
Most will expand to such sizes that are currently unimaginable. Perhaps trillions of dollars on some. Before you chuckle at this, there is a movement of spin-off into digital assets and onto blockchains. Derivatives have a real-world volume of USD 12tn.
The blockchains that fail to capture enough economic activity will slowly collapse and merge with the more dominant chains. When two industries collide, there is the formation of a new industry. This is what we are seeing with DeFi, a new standard in decentralized computing and financial services.
It has taken a few years to get mature to make an impact, but now it is rolling and unstoppable. DeFi’s impact and size will take us all by surprise in the coming months and years ahead.
Disclaimer: KR1 plc is invested in Ethereum, Dfinity, Cosmos and Polkadot and Vega.