Bitcoin’s bull run last year even prompted some of its biggest skeptics to soften their stance. From economists to hedge fund managers, the world is opening up to technology, and at the heart of that movement is decentralized finance (DeFi). While the market capitalization of all cryptocurrencies has reached $ 2 trillion and is worth as much as Apple, it is the promise made by DeFi – a tiny corner of the blockchain industry today – that is attracting the attention of institutional investors.
As the upward trend of Bitcoin (BTC) continues, interest-bearing crypto products have become fashionable. Some services offer up to 8% return on Bitcoin holdings. For investors who are already anticipating appreciation in value, this can be incredibly useful for maintaining cash flow without selling assets.
The three main factors cementing institutional interest in Bitcoin are the current historically low interest rates, the rate of inflation, and geopolitical instability. With interest rates expected to be close to zero for the foreseeable future, investors are preparing to move their funds to alternative locations to ensure prosperity.
The US Federal Reserve’s inflation target of 2% has raised concerns among investors worried about devaluation. Given the precarious tension between the US and China, US dollar-denominated portfolios are becoming riskier by the day.
A market for money
Buying, storing and using cryptocurrencies securely is still quite a complex task – far more laborious than setting up a bank account. However, according to Larry Fink, the CEO of BlackRock – a global investment management fund with nearly $ 9 trillion in assets under management – Bitcoin could move into a global market value and hit new highs in the years to come.
In the traditional financial system, money markets are parts of the economy that dispense short-term funds. They typically deal in credit for a period of a year or less and provide services such as borrowing and lending, buying and selling, with the wholesale being done over the counter. The money markets are made up of short-term, highly liquid assets and are part of the broader financial market system.
Money markets have traditionally been very complicated as expensive overheads and hidden fees force most investors to hire a fund manager. However, their existence is of paramount importance to the operation of a modern financial economy. They motivate people to borrow money in the short term and to make capital available for productive use. This improves the efficiency of the overall market and helps financial institutions achieve their goals. Basically anyone with extra cash can earn interest on deposits.
The money markets are composed of several types of securities, including short-term government bonds, certificates of deposit, repurchase agreements, and mutual funds. These funds are generally made up of stocks that cost $ 1.
On the other hand, the capital markets are dedicated to trading in long-term debt and equity instruments and refer to the entire stock and bond market. With a computer, anyone can buy or sell assets in seconds, but companies that issue stocks do so to raise funds for longer-term operations. These stocks fluctuate and, unlike money market products, have no expiration date.
Because money market investments are practically risk-free, they are often associated with meager interest rates. This means that they will not make big gains or show substantial growth when compared to riskier assets like stocks and bonds.
DeFi against the world?
Institutions are using Bitcoin to hedge against currency risks, and private investors are following their example. More than 60% of the circulating bitcoin supply has not changed since 2018, and BTC is expected to rise well above $ 100,000 in the next 24 months.
If the current trend continues, investors will continue to stock BTC. While much of the supply of the world’s first cryptocurrency remains in storage, the DeFi industry is constantly producing alternative platforms for interest-bearing payments via smart contracts, which increases transparency by allowing investors to view and track on-chain funds.
The average return on DeFi products is also much higher than in traditional money markets. Some platforms even offer double digit annual percentage returns on deposits. From asset management to checking intelligent contracts, the DeFi division creates a decentralized infrastructure for scalable money markets.
According to Stani Kulechov, co-founder of the Aave DeFi Protocol, bull market rates are high as the funds are used to leverage more capital and the cost of margins increases returns. “New innovations at DeFi use more stable coins, which further increases returns. Unless there is a new capital injection, these rates could stay for a while, ”he said.
The Ethereum network currently hosts most of the DeFi applications. This has excluded tokens that are not available on the network from participating in decentralized funding. Although Bitcoin is the largest cryptocurrency by market capitalization, it only recently found its way onto DeFi platforms.
Connected: DeFi Yield Farming explains
Kava’s Hard Protocol allows investors to farm with Bitcoin and other non-ERC-20 tokens such as XRP and Binance Coin (BNB). Backed by some well-known names (including Ripple, Arrington XRP Capital, and Digital Asset Capital Management), the platforms allow users to put their cryptocurrencies in a pool of assets that are loaned to borrowers to generate interest.
The team also plans to add support for Ethereum-based tokens in the near future. The upgrade of the network to Kava 5.1, which was postponed to April 8th after the required quorum was not met, also introduces the Hard Protocol V2, which offers powerful incentive systems and improvements to the governance model.
Most of the loans in DeFi are over-collateralized, which means the pool always has more money than it borrows. If the value of the issued token decreases, the funds in the pool will be liquidated to compensate.
According to Anton Bukov, co-founder of the decentralized exchange aggregator 1inch, blockchains are the first impartial executives in human history – very limited, but ultimately fair – and could deliver new services and new streams of interaction in the future. “Developers do their best to resolve potential dishonesty problems in existing flows and invent new flows by replacing intermediaries,” he said.
By creating an automated platform for lending and lending assets, decentralized financing enables money markets without intermediaries, custodians or the high fees that result from high infrastructure costs.
Of the many trends that DeFi has set in motion over the past few years, high-yield farming has drawn a lot of attention. Yield farming is when the network rewards liquidity providers with tokens that can be further invested in other platforms to generate more liquidity tokens.
The high yield farmers are simple in concept and are some of the most vigilant traders in the market. They are constantly changing their strategies to maximize their earnings and keep track of rates across all platforms to make sure they are getting the cutest deal. The potential return can get obscenely high, but it’s still unclear whether high yield farming is just a fad or a phenomenon. Kulechov added:
“Yield farming is simply a way of distributing governance power among users and stakeholders. What actually matters is whether the product itself would find a protocol market / adaptation. The most successful power distributions in governance with yield farming have been conducted with protocols, which prior to such programs found a market for protocols. “
Income farming has an incredibly positive feedback loop, with an increase in participation adding to the value of their governance token and fueling further growth. According to Brian Kerr, CEO of Kava, while this feedback loop can produce very positive results in bull markets, it can have the opposite effect in falling markets:
“It will be up to the governance groups of the various projects to manage the bear markets effectively by getting the rewards back before a full death spiral occurs. Regardless of the bull or bear markets, productive agriculture will be an important pillar of blockchain projects in the years to come. “
Money markets are the pillars of our global financial system, but most transactions take place between financial institutions such as banks and other companies in fixed-term deposit markets. However, some of these transactions find their way to consumers through money market funds and other investment vehicles.
Decentralization is the next frontier for finance, and with prominent investors continuing to delve into DeFi space, a decentralized economy seems all but inevitable. Participating in the burgeoning environment may be a risky bet today, but what decentralized financial platforms are learning now will lay the foundation for the robust DeFi applications of the future. According to Bukov, the higher interest rates on DeFi platforms are “completely sustainable”. He added:
“Higher profits usually come with higher risks. The risk-reward model of all these opportunities is therefore always almost balanced. Normalizing risks would decrease profits as more participants join in to share the rewards. “
From smart contract disruptions to unauthorized withdrawals of community funds, the DeFi room is a place of miracles and nightmares. DeFi-based yield farming platforms are still at a very early stage. While the numbers can be all too tempting at times, it is important that you do your own research before investing in any platform or asset.