Decentralized Finance: 5 Things You Should Know About DeFi
Decentralized finance has a real chance to ease people’s pain around money. Moving money, spending money, and keeping it safe relies on practices and technology that are very outdated. DeFi could let people snatch their control back out of the hands of rent-seeking regulators and bankers.
At Mosendo, we see the payments use case as the final puzzle piece for DeFi to go global. To support this vision, we have cultivated a creative and passionate community focused on real life usable tools called DeFi Nation. And as the co-founder of a DeFi company and that community, and have compiled five things I think everyone should know about DeFi:
DeFi has been called the “Killer App” in Crypto for good reason
DeFi, and specifically DeFi lending, has been called the “killer app” of crypto because of its value proposition: to earn high returns on stable value.
Money markets, index funds, and other slow-growth investment vehicles are popular with low-risk investors due to their safety and consistent returns. $3.3 trillion are invested in money market funds in the US alone. DeFi lending, while still unfamiliar to most, offers a similar system but with much higher returns, ranging from 7-18%, compared to returns of 2-3% in money market funds.
This means that the cryptocurrency space can now offer something to investors that looks and feels very similar to what they are familiar with! Compare that to Bitcoin. Park your funds in a lending platform, and they will earn interest just like a traditional investment.
Other crypto assets, such as Bitcoin, require a steep learning curve as well as a risk profile that does not fit many participants in traditional markets, certainly not those who are investing in low-risk assets. DeFi, on the other hand, is similar to what they know and therefore has a better chance of encouraging new users to step in.
DeFi projects are like “Money Legos” because of their composability
Ethereum has been called a “money lego” platform by Ethereum influencer Ryan Sean Adams, and others have followed suit. In the lego world, ETH is the flat piece you can build your world on. Decentralised Finance (DeFi) products, based in the decentralized stablecoin “DAI” in particular, have been hailed as immensely interchangeable financial products.
cDAI and iDAI are both examples of one of “legos” that can be plugged in elsewhere. For example, you can start by connecting your DAI in exchange for cDAI, then you can connect your cDAI onto uniswap.exchange alongside ETH to provide liquidity for the liquidity pools. The result is that you can earn additional returns by doing so, and in exchange, you receive a token from Uniswap that represents your share of that pools. That uniswap token can be traded as well.
The people who can benefit the most are the ones hurting the most
Government money or “fiat” is inflationary, meaning that if people have extra money, they have a good reason to find a different way to store it than in the local currency. In the cases of currencies with “creeping inflation,” the rate of value loss is less than 3%. Rates higher than 1-3% are known as “running inflation,” which is >10% per year, while “hyperinflation” is >50% per month. Inflation rates like these make it difficult to save money, as the value erodes over time. It also means that any excess cash needs to be held in value somewhere else, creating asset bubbles and transaction friction. 3.7 billion people live in countries where the local money has an inflation rate higher than 5%, including 680 million, with rates higher than 10%!
The DeFi movement has the power to give more people the opportunity to protect their wealth. The above example is only the inflation protection, and in fact, people using DeFi protocols also have the added opportunity to earn interest on their balance as well. This means they receive both a store-of-value in a relatively stable asset pegged to the USD and the returns earned on lending that asset on DeFi lending platforms.
DeFi is an inclusionary movement and will give access to millions who lack it
At the very least, the people highlighted above have the option to join the financial world. For the ID-less individuals of the world, no opportunities currently exist when it comes to accessing basic financial services. This means relying on informal financial services, such as savings clubs or unregulated remittances. These services can be surprisingly effective on a small scale, but carry inherently higher risks and costs.
This is the reality for 1.1 billion people or 14% of the world’s population. While many reside in developing nations, a surprising number can be found in the developed world: Singapore alone has an ID-less rate of 37%. This disproportionately affects lower-income and migrant workers, further condemning them to poverty.
Synthetic assets will connect the blockchain and traditional asset world
Synthetic assets are a bundle of other assets that track the price of a target asset on another market. Anyone who can access a market that trades synthetic assets, therefore, can have access to the opportunities found in other marketplaces.
The primary reason is near and dear to the hearts of DeFi builders: access. One project, UMA, has captured this in their name: it actually means “Universal Market Access.” Just as lenders and borrowers can connect and create mutually favorable outcomes without any centralized oversight, decentralized synthetic assets allow people to participate in any market with a price feed. This means that access cannot be limited to participants of any centralized agency’s choosing: as long as market price is public, anyone can participate with synthetic assets.
These five things are a starter pack for understanding the DeFi movement and its potential. The next important step is to try it for yourself! Get some DAI, open a CDP, or lend on a platform to earn returns. In DeFi Nation, we talk about both the how-to and also the theory of DeFi, and conversations that take place there will help shape the future of decentralized finance. We’d love to hear all about your DeFi experiences, opinions, challenges, and questions over at DeFi Nation.