With the DeFi craze recently cooling down, the value of DeFi tokens has also dropped significantly in comparison to its peak. However, interest in De-Fi remains high. Industries have shown appreciation for the establishment of a platform that enables the supply of diverse financial products through a smart contract that eliminates the need for an intermediary. Concepts such as automated market makers and yield farming, which did not exist in traditional financial markets, highlights the distinctive appeal of DeFi.
In a report titled ‘DeFi: A Repeat of the ICO craze of 2017’, Blocko asserts, “DeFi is a keyword that has heated up the cryptocurrency market and continues to garner great interest. Like the ICO craze in 2017, DeFi has siphoned off liquidity like a blackhole, demonstrating revenue amounting to hundreds and thousands of dollars.” In fact, total value locked in DeFi projects was $14 billion dollars in December, representing a tenfold growth within a period of six months.
#Hot DeFi Topics This Year
– from loans to yield farming and the presidential election forecasting market
Blocko’s report defines DeFi as an ecosystem that was created to make various financial products and services, such as savings, loans and insurance, accessible to all people without intermediaries through automated algorithms based on decentralized protocols and applications. The report goes onto explain that blockchain has expanded from being focused on simple transmission of value through various digital asset wallet services and smartphones into an intricate and complicated financial model.
So, what kind of DeFi services are there? According to Blocko’s report, representative services include DEX (decentralized exchanges), borrowing and lending, stablecoin, prediction markets, yield farming, liquidity mining and synthetic assets.
Among these, the fastest growing service is the lending platform. Borrowers and lenders are linked by a smart contract where users are able to borrow other assets using their cryptocurrency as collateral or earn interest income by lending to other users. Determination of the market value of each asset, calculation of the minimum collateral coverage ratio and the liquidation of a vault when the ratio falls all occur automatically through the smart contract. Compound and Maker are examples of leading lending platforms.
Yield farming is a DeFi market keyword that has made crypto enthusiasts and investors this year very excited. This revenue model distributes governance tokens as a reward in addition to profit for users who provide liquidity through cryptocurrency deposits. Blocko’s reports states, “Although similar to other mining strategies in terms of offering participants a reward, it differs in providing all users of the platform, not just miners, with incentives. Synthetix, in March, and Compound, in June, particularly soared in popularity this year.”
This year, prediction markets for the US presidential election also attracted great interest. Augur, one of the major predictions platforms, alone reported over $4 million in open interest. Betting related to the presidential election also accounted for 91% of all transactions on another popular platform, Polymarket.
#DeFi’s Distinguishing Features
– from AMM to Forking
Blocko identifies the automated market maker, impermanent loss and yield farming and forking as the three main technological trends of the DeFi industry this year.
The automated market maker is an algorithm that decides the price of a certain asset by relying on a mathematical formula and is used by most decentralized exchanges. Blocko’s report explains, “In contrast to the original order book method where transactions are completed only when the price and volume of the buy orders and the sell orders match, the AMM’s appeal is that it enables immediate transactions by use of a smart contract in which various assets have been deposited.”
Impermanent loss refers to the potential loss of funds experienced by liquidity providers of AMM-based transaction platforms. A transaction platform needs to maintain an adequate liquidity pool but changes in asset prices can lead to impermanent loss. In other words, assets that have been deposited in a liquidity pool are more susceptible to loss than held assets. Exchange platforms must provide liquidity incentives to offset the opportunity cost of impermanent loss. Most transaction platforms have begun to offer governance tokens in addition to transaction/interest revenue. Examples include COMP, UNI, YFI and BAL. But the listing of governance tokens on exchanges and subsequent rises in prices have intensified competition between platforms. Blocko’s report asserts that, “Increased investment in governance tokens driven by hope that prices will rise has kickstarted a game of chicken between the transaction platforms.”
Increasing interest in AMM-based transaction platforms and governance tokens has led to the emergence of forks created by ‘copying and pasting’ an existing code and publishing it under a modified name. It exploits the appealing open-source nature of DeFi, which makes source codes and smart contract codes accessible to the public. A representative example is Uniswap’s fork SushiSwap. Blocko explains, “In reaction to SushiSwap’s higher offer of interests and rewards, millions of dollars in liquidity migrated to SushiSwap in a matter of days. The cryptocurrency community has mockingly labelled this the ‘vampire mining protocol’. However, there has also been an emergence of upgraded fork protocols that make up for the weaknesses of the original protocol. A representative example is Compound’s fork Cream.”
The report continues, “The future direction of the open-source DeFi market, which allows anyone to freely participate, contribute and audit codes, is undecided.” However, the popularity of the DeFi market remains unabated. Blocko’s CEO Won-beom Kim states, “The reason for people’s enthusiasm for DeFi is simple. It’s because new financial concepts, which the traditional financial market could not offer due to institutional and social barriers, have become realized through blockchain.”