DeFi (Decentralized Finance)
DeFi (Decentralized Finance) is a term coined by platforms that offer financial services through smart contracts. It’s an idea that anyone with a web browser and some cryptocurrency can take out a loan for any purpose without a lengthy underwriting process, credit check, or regulatory approval. DeFi focuses on the Decentralized part of the definition and most of the lending, borrowing, APR rate calculation is automated in the smart contracts, so anyone can take advantage of their services.
One of the most popular DeFi platforms is Compound, with $1.5 billion assets locked as collateral this platform allows for people to deposit their crypto and take out loans against it. The platform built a dynamic rate calculation engine, where the savings and lending rates are calculated based on the demand and supply of the underlying collateral. To take advantage of this platform, one has to use a Chrome browser extension called MetaMask. MetaMask is a web crypto wallet that allows you to connect to different DeFi web platforms and interact with their underlying Blockchain infrastructure.
Compound is just one example of the DeFi infrastructure that’s being stood up. Just like lending is only a small component of traditional financial system. Other DeFi platforms start to appear with use cases ranging from Decentralized Cryptocurrency Exchanges, Decentralized Loans, Decentralized Insurance, Decentralized Funds, and many more appear every day.
DeFi success is dependent on adoption and network affect. In order to take out a loan, people have to first deposit their crypto collateral. To incentivize people to deposit their crypto savings, DeFi projects started the practice of Airdrops and native token giveaways. Airdrop is a process of sending free tokens to a set of addresses to encourage platform usage and further adoption.
Usually Airdops are only a few dollars worth of tokens and distributed to all the users. A few days ago Uniswap project did something different. Uniswap issued an Airdrop for early users of its platform and gave away 400 Uni tokens to anyone who tried to use their platform prior to September 1st. Uni tokens quickly got listed on most exchanges and now it is traded at ~$7 per token on Coinbase. Doing quick math each early adopter was rewarded with $2,800 at current prices. If you educated your spouse and he/she used her own MetaMask to try a UniSwap transaction before September 1st, then you got $5,600 per couple at current prices.
In the times of economic slow down and lawmakers unable to pass the next stimulus bill, the Cyptocurrency community essentially got a stimulus of their own. Other DeFi projects are jumping on the bandwagon of Airdrops. Tron network, Crypto.com, Binance are launching their DeFi platforms and rewarding users with their tokens.
Risks Of DeFi
I can’t write about DeFi without highlighting the risks. When posting your tokens as collateral in any DeFi platform, you are risking that collateral to be stolen in a hack. Smart Contracts are nothing more than open source code running on the network. Any hacker can easily read the code of any DeFi contract and look for vulnerabilities. So, when putting your tokens as collateral, please keep in mind you are a part of the large honeypot with millions in rewards for a smart hacker to take. Luckily, we now have Decentralized Insurance to help and pay back in case of a hack, but even that is not battle tested yet.
Given all that, I would recommend to keep the majority of your crypto investments in the cold storage, disconnected from the Internet. You can play with DeFi with a small % of your portfolio just to gain understanding and follow this trend. In case of Uniswap even a failed transaction would qualify you for a $2,800 payout, so with that I would say it’s ok to explore DeFi and try it out.
Musical Chairs and The End Game
I will go out on the limb and make a prediction. DeFi crazy valuations, token airdrops, and incredibly attractive yields are going to continue. The more people learn about the rewards, attractive yields, DeFi insurance, and airdrops than more they join and contribute. Cryptocurrency market cap today is $356 Billion, but the total value locked in DeFi is only $9.8 Billion. More and more coins, tokens and platforms will incentivize users to try their services, while their native tokens will see a meteoric raise in value. All of this will end with a big event of historic proportions. A hack of a decentralized contract stealing hundreds of millions of collateral and an instant withdrawal of funds from other protocols. This is what a classic game of musical chairs is. If you are smart and methodically take your DeFi gains, if you use stop losses on your DeFi trades you can play that game. Taking it a step further, if you are really smart, you would play this game and convert your earned DeFi value to Bitcoin. Stacking Sats, as i explained in my last article, is the end game for Crypto. This should be the only end game until DeFi is battle tested.
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As usual, none my articles or charts here constitute a financial advice. You and only you are responsible for your financial decisions.