Over the past year, the decentralized finance space has made waves in the financial sector, building on blockchain technology to decentralize a wide variety of banking services. The adoption of DeFi services has steadily increased, and all types of assets are finding their way onto the blockchain.
With non-verifiable tokens popularizing the representation of digital art owners, blockchain technology is creeping into the most unexpected places and DeFi is pushing its expansion. These unique and sometimes very valuable tokens are particularly relevant today. Art galleries are closed due to restrictions related to the global pandemic and cultural experiences that are happening online now more than ever.
In 2020, DeFi saw an explosion in the way liquidity can be generated, with marketplaces for financial products, community-based social and governance tokens, and unique works of art. A significant amount of Bitcoin (BTC) is used as a store of value these days, but that’s not what it was made for. Slow transaction times, high fees, and a history of rising value hamper the use of Bitcoin as a payment system, but that hasn’t stopped the blockchain industry from creating others.
The advent of programmable smart contracts catalyzed the formation of our modern decentralized financial ecosystem, making financial services accessible to anyone with an internet connection. The expensive overheads of central banks have made international remittances slow and uneconomical for most use cases. However, by implementing a number of interweaving protocols, decentralized funding offers alternative ways of distributing value to different communities around the world.
The traditional financial system works for most, but it could do a lot better. While blockchain isn’t ready to pull the cloak from it, today’s decentralized networks have great ambitions, and as access to digital assets continues to improve, people around the world are increasingly engaging in the global economy without trustworthy intermediaries, banks, or lawyers . With more development resources for DeFi systems than ever before, blockchain is the next frontier for any financial services company worldwide.
Scattered but heavily
The Internet has changed the flow of data and information around the world, and this development of communication channels has profoundly influenced the banking system. As the world shifts to platforms that offer faster registrations, faster service and more reliable products, the possibilities of centralized banking stand in stark contrast to one another.
Smart contract platforms enable interaction with multiple decentralized applications using a single financial identity. With nearly 2 billion people in the world inaccessible to financial services, it is in everyone’s best interest to lower the barrier to entry.
In fact, some centralized banks even offer cryptocurrency management services that allow users to securely store their cryptocurrencies with a party who can be held responsible for their security. While this seems to go against the ethos of decentralization and blockchain, centralized custodian services could actually be beneficial to the broader industry.
Brian Kerr, CEO of the Kava DeFi platform, told Cointelegraph, “For me it is a natural evolution of banking, finance and the evolution of fintech services for a bank to use Kava in the backend to keep loans and great APYs securely attached to theirs User to deliver. ”
According to Kerr, holding cryptocurrencies is much more frightening for the average person than it is for fiat because transfers are irreversible, which makes mistakes all the more costly. “I believe banks that support digital asset custody are a big step in making crypto available to mainstream users,” he said.
However, as fintech companies continue to improve their products and services to provide better experiences for the end user, the current development pattern has not changed much in the past few decades. As Anton Bukov, co-founder of the 1-inch decentralized exchange aggregator pointed out, the APY for lending and borrowing will decrease in the future as banks begin to provide enormous amounts of stable coin liquidity to DeFi platforms.
Over time, networks have evolved to meet different needs. With Web 3.0, blockchain is not only decentralizing power in financial systems. it redefines value. In the near future, these systems are likely to grow stronger and eventually be seen as a valuable proposition for all types of businesses.
The rollout of automated market makers was a key contributor to both decentralized finance and the overall blockchain growth in 2020. Before AMMs, decentralized exchanges weren’t nearly as popular as they are now. Instead of using order books to remotely match trades, AMMs let users trade with a smart contract, which improves liquidity and eliminates counterparty risk.
Since decentralized exchanges like Uniswap occasionally report a higher volume than Coinbase Pro, there is talk of whether centralized exchanges are sustainable in the long run. While DEXs have certainly improved in recent years, replacing order book exchanges doesn’t seem to be on the agenda.
As trading fees have become increasingly competitive, the services offered by cryptocurrency exchanges have also become increasingly competitive. From initial stock market offerings and equity holdings to credit and credit services, exchanges could begin to defend their positions by increasing margins from other businesses and facing competition from their decentralized counterparts. “Just as banks don’t make deposits, so do they make back-end services and cross-sell other financial products – as does centralized exchanges as the industry advances,” said Kerr. Bukov added:
“Coinbase cited DEXs as one of the biggest risk factors for their business while preparing for the upcoming IPO. I think they could try to compete in this area too by offering their own L1 solutions or DEXs, for example. “
In short, an AMM consists of token-pair pools, the ratio of which in the pool determines the price of the individual tokens. Uniswap is currently the most popular AMM DEX that allows anyone to join pools of liquidity for any pair of tokens. This provides the pools with liquidity and at the same time increases the risk for the participants to achieve part of the return.
As AMMs get more complex, some platforms have even built in features like multi-token liquidity pools and more efficient algorithms for calculating asset prices. Unlike IEOs, there are no gatekeepers preventing someone from starting a token or platform. While this can be exploited by users with malicious intent, it could lead to some very interesting projects in the years to come.
Interoperability is in
While most DeFi applications are currently running on Ethereum, interoperability is slowly becoming a reality. This gives developers the freedom to choose different platforms that best suit their individual decentralized applications. With platforms like Cosmos and the substrate-based Polkadot, developers can now even create interoperable blockchains tailored to the needs of their application.
Today, developers rely on monolithic layer-one blockchains that provide open, intelligent contract platforms. “These platforms try to do everything well and nothing great,” said the Kava CEO. “With interoperability, these platforms will continue to be useful for prototyping in the future, but developers will choose the most specialized and optimized services for their app and use cases.”
One of the biggest trends in late 2020 was the increased demand for access to liquidity and economic activity from Ethereum via other blockchain-based protocols. From packaged bitcoin (wBTC) to blockchain-based data storage, storage space has seen a surge in activity on cross-chain platforms.
For example, Kava, which was built using the Cosmos framework, has seen significant growth. It offers secured loans and investment opportunities for various cryptocurrencies. The platform uses its Kava token to control and secure the network by staking out.
With such governance tokens, network participants can vote on critical parameters such as the system’s global debt limit, the collateral ratio and the savings ratio. In cases where the system is undercollateralised, the Kava token even acts as reserve currency that needs to be minted and sold until the system is re-secured.
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Both Ethereum and Cosmos require a significantly higher number of validators per chain than Polkadot. Compared to Ethereum’s 111 validators per shard, Polkadot’s claim to provide equivalent security with at least five validators per chain requires more analysis.
The low minimum number of polkadots allows for easier collusion between validators for individual parachutes, and the DOT slashed by malicious validators is also slashed by nominators. Coupled with the lack of a minimum wagering requirement, this could lead to some risky situations from a nominator’s point of view.
Cross chain crossing
The growth in decentralized finance has been unprecedented and overwhelming. The monthly DEX volume has exceeded $ 55 billion, which is also the current total market cap for stable coins. DeFi outstanding debt is over $ 9 billion, but decentralized funding is still a toddler compared to the broader financial services industry.
With new innovations just around the corner, there is good reason to believe that the accessibility and variability of DeFi applications will improve over time. As gas costs on Ethereum continue to fluctuate, sometimes to prohibitive levels, blockchain projects are looking for better scalability solutions like Layer Two protocols. Ethereum 2.0 promises to solve many of the problems its predecessor is currently facing. How well the network works in practice will, however, only be known in good time.
As long as gas costs fluctuate, the DeFi protocols will continue to attempt to poach users and thus liquidity from Ethereum. Another problem the DeFi space faces as an infant industry is its reliance on an experienced user base. Today’s applications are typically aimed at dealers familiar with DeFi systems and provide services that are not always useful to the average consumer, e.g. B. Auditing tools and on-chain data oracles.
As the industry continues to expand its capabilities, projects continuously create better utilities for DeFi tokens. Some platforms even now allow non-fungible tokens to be used as collateral for peer-to-peer loans, increasing the liquidity of these digital collectibles to the level of other monetized assets.
“I firmly believe in the future of NFTs as a primitive or financial construct. Most of the time, NFTs are stupid these days, ”Kerr said. While NFTs are incredibly powerful as a concept, transferring the power of blockchain technology to areas such as real estate and intellectual property, DeFi requires deep, liquid markets for a collateral value to be useful. “It will be a long time before NFTs are useful as security for DeFi. By definition, NFT markets are very illiquid and therefore offer terrible collateral, ”he added.
According to Bukov, co-founder of 1 Inch, decentralized finance projects should exhibit NFTs, sell at auctions, and donate a significant portion of the profits to charity. DeFi’s advances in recent years look promising for the future, but while DeFi has accomplished a lot in its short lifespan, its prime is likely to come.