The Rise of Decentralized Finance (DeFi) in Crypto

By Amir K

What is DeFi’s relationship to Ethereum?
Ethereum, which is currently the second largest cryptocurrency in the world by market capitalization, distinguishes itself in providing one of the world’s first Turing Complete protocols, meaning programmers can use the Ethereum programming language to build their own Ethereum “Tokens” that can be swapped to and from Ethereum and are complete cryptocurrencies in their own right, which is a feature previously impossible on cryptocurrencies such as Bitcoin. The most popular Ethereum tokens at the time of writing:

The most popular Ethereum tokens at the time of writing:

Source: CoinMarketCap.com

It is important to note that three of the above currencies are currently in the top 10 and all of them are in the top 20 in the world by capitalization.

What is DeFi in a nutshell?
In a single statement, it is conventional finance and its applications deployed in a completely decentralized fashion, specifically on the Ethereum protocol thanks to the possibility of the token swaps aforementioned. It is meant to provide permission-less, peerto-peer access to financial services for those who are currently unable to do so by conventional means for one reason or another (for example if a low credit score disallows a person from getting a loan). Its growth has been incentivized by the fact that centralized institutions often entail a much higher transfer fee at more than double the price for equivalent services in most instances as well as the fact that more people now have access to the internet than ever before, and the ease of use of a peer-to-peer decentralized system in addition to the condition-less services provided have been contributing factors in its prosperity.

What proportion of the crypto market is in DeFi and what is the projected growth of this sub-field?

Source: Boston Consulting Group report on DeFi

The above figure is an illustration of the “Total Value Locked” in the DeFi landscape over the past 3 years. With the recent success of applications such as the novel yield farming that allowed YFI to skyrocket by more than 5000% over the course of one month, investors and developers of DeFi applications are beginning to discover its potential use-cases, thus making it likely that we are still in the discovery phase. The proportion of DeFi with respect to Ethereum is modest: roughly 15% (Forbes, Kauflin, 2020). The above graph, however, demonstrates that its rise has been exponential in the past few months and this number is likely to increase.

Isn’t DeFi dangerous because of its implications?
In August of 2020, Forbes called DeFi “a nice dream” but one that everyone in the world of crypto is talking about. [https://www.forbes.com/sites/investor/2020/08/14/defiwelcome-to-the-crypto-revolution]

Of course, there is the undeniable problem of DeFi being fundamentally hard to track due to its decentralization, with major concerns for lenders, investors into Tokens with new smart contract vulnerabilities discovered (here is how one clever trader exploited a smart contract to make $250,000 out of $200 in a matter of minutes: [https://www.forbes.com/sites/cryptoconfidential/2020/09/13/defiinvestor-turns-200-into-250000-sushiswap-crash-sinks-ether], and everyone in general due to the fact that should this be used for criminal activity akin to Bitcoin’s meteoric rise in popularity during the Silk Road era (dark web website for drugs), the market will likely experience a steep correction as authorities figure out how to navigate this field, with a good chance of it becoming banned. This scenario has already played out in history with Bitcoin either being entirely or temporarily banned in certain countries, with some requiring its purchase through centralized exchanges now (CEXs). That being said, there is a powerful element of control associated with DeFi: the smart contracts themselves that are built on the Ethereum protocol are programmable, meaning all the tokens are subject to the programmatic expression of the will of its developers. This gives DeFi as a market an advantage since newer coins can be developed to comply with required and evolving regulations and those in place can adapt its contracts as well. However, there is still the element of risk involved: Andre Cronje, the founder of YFI, noted that the risk for lenders right now is unsustainable and too dangerous in his opinion, but he is also actively working towards mitigating this with new solutions and believes that with time the field will rectify this problem since we are in the initial stages of the DeFi market.

Is DeFi a good investment opportunity?
Cointelegraph (amongst myriad other news publishers) recently published an ambivalent eye-catching article titled “DeFi is a ‘once in a decade investment opportunity – True or False.” [https://cointelegraph.com/news/defi-is-a-once-in-a-decade-investmentopportunity-true-or-false].

At the very least, this speculative question is a positive sign that the field is probably yet to evolve and is worth consideration and learning about. As the article points out, the state of DeFi right now is one in which most traders ponder whether we are in a “bubble” or a sub-sector of an ever-rising projected trillions-of-dollars cryptocurrency market. The current scape is reminiscent of both the dot-com bubble and cryptocurrency market trends, with the notable few such as Amazon.com and Bitcoin surviving and thriving following violent crashes. DeFi is unlikely to die out completely due to its positive implications, and as it was the case with the prior two comparisons, a prudent investment now may potentially be highly profitable.

If you are interested in learning more about DeFi, Forbes has numerous interesting articles published over the last few months that I heavily recommend.


Disclaimer
The authors of this publication are not qualified to provide financial or investment advice and as such the content provided should not be construed in this manner. All information is intended purely for educational purposes and is provided for the personal interest of UNIT members. The opinions expressed within the article do not reflect those of UNIT as an organisation, its partners or its sponsors.