Ethereum’s Decentralized Finance Ecosystem: A Legitimate Threat to Traditional Banking
Decentralized finance (DeFi) is the newest trend to ride on in the blockchain ecosystem. Ethereum alone boasts a number of different financial services, of which the likes of MakerDAO and 0x Protocol are already scaling to the top of the DeFi mountain. In this write-up, BTCManager explores the intriguing world of decentralized finance.
Overview of the System
Blockchain finance can be broadly grouped into infrastructure, payments, investments, lending & insurance, and marketplaces; each of these categories has subcategories that diversify the functional goal of the system and complement each other.
Of all these categories, infrastructure and payments sit at the top of the chain as the most crucial systems for smooth function. It complements each of the other categories in a very direct way – without infrastructure for services to run on and payments to facilitate exchange, lending, insurance and investments, the marketplaces literally cannot function.
While infrastructure and payments are the base of the design, the secondary categories form an ecosystem and are what provides real value to end users. Investments are the reason for business loans being issued on the lending platforms and marketplaces are made more robust through the added liquidity from lending and investments. All of this essentially ties together to form a synergistic ecosystem of services that are decentralized and market-oriented to benefit customers.
As discussed, this is an element that forms the absolute base to power a decentralized ecosystem.
0x Protocol and DutchX are two of the most important infrastructure projects. 0x, which powers decentralized exchange and is utilized by nearly ever DEx, forms the backbone of the payment remittance ecosystem. DutchX is a smart contract platform launched by Gnosis for Dutch auction styled contract issuance and governance.
Infrastructure is defined beyond simple financial infrastructure – the scalability of the base chain, which is Ethereum, is a critical factor in determining the speed and throughput the network can handle. Even before payments come in, infrastructure is necessary to make sure the payments can be facilitated, making it the ultimate requirement to create any sort of technological ecosystem.
Payments and Custody
This covers the entire breadth of the payment process – from sending and receiving tokens to storing them. The most important players here are MyEtherWallet, MetaMask, and Raiden.
MyEtherWallet allows for storage of ETH and ERC-20 tokens while MetaMask allows users to run dApps and make payments through browser integration. Raiden is an off chain scaling solution designed to improve micropayments with faster transactions confirmation and lower fees – simply put, Ethereum’s take on Lightning Network.
Other payment protocols exist over the Ethereum network and they all play a similar role in helping propagate money from one place to another.
While Dai is the most used Ethereum based stablecoin, it is a component of the lending ecosystem from MakerDAO and hence not a ‘pure’ stablecoin. Melonport is an open source protocol that allows for asset management in the digital space; participants can build their own strategies and portfolios to display for the public – anyone can invest in these portfolios if they feel it is suitable for their investment goals and falls in their risk appetite.
Brickblock is another blockchain platform that allows developers to raise funds for their real estate projects and investors to put their capital in real estate without the huge capital needed for private real estate investing. Both of these protocols represent different edges of the investment dimension of DeFi. Real estate is known for its wealth creation properties and it’s high capital requirements; the protocol on Brickblock allows users to invest small amounts into individual real estate projects – something that wasn’t possible till the distributed ledgers came along.
Stablecoins are an essential part of the investment network in cryptocurrency. As BTCManager reported, stablecoin adoption has been soaring in 2019, owing to the need for an easy hedge to overcome the pitfalls of a hyper-volatile investment class. USDC, launched by Circle, is a centralized stablecoin that has gained institutional adoption while Dai is a decentralized market derived stablecoin that is supplied through the MakerDAO network.
A special shout-out to dYdX which recently launched as in facilitating the first viable derivative trading model on the Ethereum blockchain.
Lending & Insurance
Loan issuance and lending is perhaps the most penetrated and publicized dimension in the DeFi ecosystem. With various players with proven capability and viable business models, this space has become a trademark of Ethereum’s ability to create end products.
MakerDAO, Dharma, GetNuo, Compound, and Bloqboard are the high potential lending platforms that can truly disrupt traditional finance. MakerDAO’s key feature is the ability to collateralize Ethereum for stablecoin loans, Dharma and GetNuo both allow the issuance of non-fungible bond tokens as a way for corporates to raise debt, but Dharma loans are mitigated for risk through a decentralized network of underwriters who decide the terms of the loan based on the recipients risk profile.
Compound, which recently launched its newest rollout, stands out for allowing interest rates on loans to be decided by market sentiment. All in all, the lending dimension has an abundance of talented developers and governance experts who are turning it into the most penetrated use case for smart contract platforms.
Insurance is not as well penetrated, with leader Etherisc, not gaining as much traction as the lending platforms have. Etherisc allows users to collectively build and subscribe to insurance schemes such as hurricane protection, crypto wallet insurance, and crop insurance. This category has a ton of potential and can be expected to pick up as the DeFi capabilities on Ethereum start to scale faster.
This covers online markets and prediction markets used to make customized bets. The most reputed players in this space are Augur, Gnosis, and Rare Bits. Augur and Gnosis are prediction markets for eccentric bets, but they haven’t been able to garner many users, with Augur, in particular, having low liquidity despite massive market cap.
Rare Bits is an online marketplace to discover, buy, and sell digital assets. In this context, digital assets doesn’t mean utility tokens – it refers to collectible cards, crypto kitties, and other niche items. Online marketplaces on Ethereum are gradually gaining liquidity but are still nascent and haven’t been able to attract users
Tying Everything Together: The Big Picture
After a clear insight into each dimension of the DeFi ecosystem, it becomes fairly evident how everything will tie up and serve to complement each other. The current financial system is a dog-eat-dog world – every company enters each of these dimensions to try and become the single largest entity – or as the US government calls them, institutions that are ‘too big to fail’.
With multiple options in lending, investment, and marketplaces, decentralized finance has no systems that are too big to fail. In this world, it’s less about brand value and more about how well it works. Moreover, platforms compete within their own segment and don’t try to enter a ton of different markets and become a conglomerate. As Moody’s has highlighted, the advent of DeFi is most definitely a threat to the financial system; it’s spread out, it works, and it embodies a much-needed power shift from businesses to consumers. The only thing left is to scale these systems so they can cater to the needs of the masses – and that will come with due time.