The word DeFi, short for Decentralised Finance, as a term is becoming more and more recognized yet it is only just the beginning. The invention of smart contracts in Ethereum in 2014 and other EVM compatible or smart contract capable blockchains coming on to the scene from then onwards, decentralised finance has been a possibility for many years, however, it has only just begun to gain traction in the last two.
In a now infamous introduction video about Ethereum, Vitalik Buterin broached on the possibilities of smart contracts and decentralised finance (here forth DeFi), however as recently as the beginning of 2019, the Total Value Locked (TVL) was only minor sums in the thousands for the entirety of the sector.
Although the first mover, Ethereum has lost enormous market share in just a year. At the beginning of 2021 the percentage of TVL in Ethereum was 97% and today (14 March 2022) it is 55% — a dramatic 42% difference. However, with that said, the main point of this article isn’t about the dominance, or lack thereof of Ethereum; it is to highlight that the space is incredibly nascent, governments might play an important role in facilitating innovation and that whilst trends emerge suddenly, others may fade just as quickly as they appeared.
Since the DeFi summer occurred in 2020, the main players, both blockchains and projects, have changed a number of times and it’s anybody’s guess where we are headed next. The addressable market of TradFi (traditional finance) is enormous estimated $400T where fees account to a whopping 10%. Regulation is being implemented globally to ensure that DeFi is here to stay and we can only see the tip of the iceberg — DeFi’s most innovative products and killer apps are likely still yet to be imagined.
Tradition Finance vs. Decentralised Finance
Before we understand what DeFi actually is, it is worthwhile to be familiar with the differences between DeFi and TradFi, or Traditional Finance. TradFi is the finance world that DeFi is disrupting. Money is held by banks and corporations who’s the main goal is to make money from our money. It is slow and full of third parties that charge fees for using their services — essentially passing your money around from A to B to C and so forth. Much money moves around between parties in an antiquated way that each party gets their cut and the user must request permission from their chosen financial in order to access their money whether travelling or have onerous conditions placed upon them when applying for a loan — which can take days to approved or not.
On the other hand, DeFi came about from the imagination of developers who are realizing the power of smart contracts and more in cryptocurrencies. As crypto has quick finality, even a bitcoin transition can meet finality within an hour, it beats TradFi by orders of magnitude — it isn’t unreasonable to days or weeks for funds to settle.
“Finality of settlement ensures that transactions made over payment networks will, at some point, be complete and not subject to reversal even if the parties to the transaction go bankrupt or fail.”
By writing code that allows users to essentially transact peer-to-peer with comparably low fees when exchanging tokens or high-interest rates for lending as well as almost instantaneous approval to borrow against their own collateral — DeFi is very real, revolutionary and is formidably disrupting a market that is worth hundreds of trillions of dollars.
Early DeFi projects and emerging trends
Some of the key characteristics of DeFi is that it is non-custodial, open, transparent, composable and decentralised. The DeFi field isn’t short of innovation and there isn’t a day or week that goes by that a new product comes to market looking to provide a new take on an old system. It is essentially a blanket term for a variety of financial applications that will disrupt financial intermediaries, such as banking, insurance, exchange, real estate and more. Whether it was MakerDAO in the early days or crypto (2015) to more recent forays such as the Decentralised Exchange, or DEX, Uniswap (2018) or Curve Finance (2020) — the space is constantly evolving to the needs of its users and the boundaries that are or are not set by the law. However, some of the more imaginative DeFi applications in recent times include Fractionalised NFTs and Centrifuge.
NFTs were many people’s first introduction to the world of crypto or DeFi — the world NFT itself (Non-fungible token) was the Collins Dictionary ‘Word of the Year’ in 2021, as it has worked its way into many people’s lexicon through the hype and buzz that has occurred surrounding sales of digital art.
By virtue, an NFT is a one of a kind digital piece of art that might be a picture, a video, some music or a combination or all three — yet it is completely and utterly unique. Let’s not delve into copycat works on competing blockchains — for now.
One of the reasons that NFTs has risen to become one of the most well known words and edgy concept in 2021, for better or for worse, is the price that these ‘items’ have been selling for. Beeple was groundbreaking when he sold an NFT for US$69 million in 2021 making his works some of the worlds most valuable and him the worlds 3rd most valuable living artist in terms of auction prices after David Hockney and Jeff Koons.
Not everyone has 10s of millions of dollars to spend on art — enter fractionalised NFTs. Just as the name implies, it entails percentage ownership of an NFT on the blockchain which presents new opportunities and potentially even higher evaluations. The original DOGE picture that has spawned memes and it’s own cryptocurrency itself sold as an NFT for US$4 million in 2021.
It was later sold again where potential new buyers could own a fraction of it for as little as $1. The project was wildly popular with many purchasers getting a digital piece of internet history and now the fractionalised version of the NFT is itself at time of sale was valued at over $300 million.
Another project that launched in 2021 and is just beginning is called Centrifuge — ‘the home for real-world DeFi on Polkadot’ as they say on their website. What is real-world DeFi, one might ask. Through the first part of Centrifuge, Tinlake, owners of real-world items like art, property, mortgages and more into a pool that is open for investors to deposit or invest into. Once that off chain document is on-chain in the form of an NFT — any user can see what the NFT and verify who the owner is and what it is worth in the real world. Therefore, if one owns an NFT that represents a real-world mortgage through Centrifuge — they would be entitled to the payments of the mortgage via smart contracts that automatically execute through the platform. Centrifuge is an incredibly inventive project that has just been on-boarded onto the Polkadot on 11 March 2022. The project currently has over $75 million in TVL.
What does the law say?
In November 2021, Balaji Srinivasan, former CTO of crypto exchange Coinbase, spoke at Solana’s Breakpoint conference in Lisbon, Portugal. His speech was largely about the attrition between lawmakers and crypto companies and the need to establish legality as the layer 0 — in reference to layer 1 blockchains the dApps being built upon them. More fundamentally, Balaji sees that it is essential to be clear about what is legal and allowable in the blockchain world, and therefore DeFi, in order to encourage creative and intuitive uses of this relatively new and very disruptive technology.
Against the grain, El Salvador adopted bitcoin as a legal currency in 2021. Although that was a first as a nation-state, this trend has been happening more and more in different pockets of the world with the Swiss city of Lugano adopting Bitcoin as a currency in 2022 and other crypto-friendly cities emerging such as Miami, New York, Texas and more. In line with what Balaji said at the conference, he believes that by establishing crypto-friendly cities, technologists will continue to influence innovation first at first localised and then ultimately at a national and international level.
The following month in December 2021, the US congress lead a hearing with 6 cryptocurrency CEOs in order to testify to the federal government in order to inform their decisions about implementing a new bill and laws to foster competition and innovation in the United States and ultimately the world. Lawyer and CEO of Bitfury, Brian Brooks advised that the current regulations or lack there of were stifling for innovation and were responsible for the US losing a competitive advantage.
As a response, US President Biden signed an executive order this week regarding regulation of the cryptocurrency sector in the US.
Largest Companies and The Internet
Jeremy Allaire the CEO of Circle, a leading US$ pegged stable coin company, called Biden’s order a watershed moment for crypto assets, DeFi and web3, akin to the 1997 whole of government waking up to the commercial internet.
Just like the early days of the internet, there was a lot of development and entrepreneurship occurring but there was also a lot of uncertainty about how to regulate it and the kinds of posture that the government ought to have in regard to competitiveness in regard to innovation in the technology and these are the same kinds of questions that the world is looking to answer in regards to crypto, DeFi and web3. The executive order essentially orders federal agencies to get smart about the topic at hand and not to legislate willy nilly but to ensure that decisions are being made with consideration and carefully implement regulations that look at every angle. Accordingly, it will ‘support responsible innovation that could result in substantial benefits for the nation, consumers and businesses. It will also address risks to illicit finance, protecting consumers and investors and preventing threats to the financial system and broader economy’.
If we were to look at the 8 largest companies by market capitalization in March 2022, there is only 1 that isn’t a technology company.
If during the 1990s the US had chosen another path, a more restrictive path by clamping down hard in regulating the internet, it is likely that 7 of these biggest companies that exist today would not exist as they do today. Sure, those companies might have come into existence still, but they likely would have been established somewhere else — and not in the US. It is unlikely that the Clinton administration would have imagined in their wildest dreams that these companies would become so significant — however, history shows us what happens.
South Korea also elected a crypto-friendly president, Yoon Seok-youl, who will come into power in May 2022. In the lead-up to the election, Yoon said in January 2022 that
“We must shift to a negative regulation system to ensure at least the virtual asset market has no worries,” he said.
In the same speech, seemingly recognizing the importance of digital assets for the economy and people of South Korea, he called for measures to enable the virtual assets industry to produce unicorns, that is privately held start-up companies that are valued at over US$1 billion. While the impact of his presidency on digital assets and DeFi remains to be seen, for both investors and start-ups alike, his victory is largely seen as a positive for the industry. Implementing clear regulations or deregulations give both investors safety to invest and start-up companies within the space the clarity needed in order to build innovative products and shape the industry.
Inflation for the US dollar (the world reserve currency) is at 40-year high due to the printing of money during the global health crisis and is officially 7.9%, however unofficially it might be somewhere from 15–20% based on CPI figures. Former Treasury Secretary Larry Summers said this week that The Fed is ‘well behind’ the curve on inflation and should stop stimulus as soon as possible.
In a play on words from Meta’s (previously Facebook) famous internal moto ‘Move Fast and Break things’, Robert Hackett wrote about the innovation occurring in DeFi in an article titled ‘DeFI: Move Fast and Bank things’ and discusses the financial revolution that is taking place in the digital asset world, and how it is shaking up how people invest or gamble with their money.
People, and companies, cannot afford to have their money disappear by holding it in fiat or underperforming TradFi outlets. According to Stuart Sopp, CEO of Current, “Money goes where it is treated best. If you can get a 5% yield and it’s pretty safe, then money will move”.
Gradually, municipalities in various pockets around the world are becoming crypto-friendly as are governments of various countries. Innovation cannot be stopped; governments will only stop where this innovation will occur at a national level. DeFi takes place online and across borders, around the clock. Considering the parallels between the internet and crypto and the room for disruption, especially in DeFi, we are very likely to witness a financial revolution occur right before our eyes.
