The decentralized finance industry is a revolution happening in the banking industry slowly but surely.
There are three main categories of Defi providers in the crypto-sector, most of whom operate via the Ethereum blockchain and its supported protocols. I label them as a) Centralized Defi service providers b) Decentralized Defi service providers and c) Auxilliary Defi Service providers.
Centralized Defi Service Providers
On one end of the decentralized finance, product spectrum are centralized entities such as celsius.network and nexo.io that have found innovative ways to return positive returns on cryptocurrency investments, by lending with collateral. Let’s call these centralized Defi Providers. They operate similarly to banks, often acceding to large customer service support, providing and maintaining KYC records for all customers, negotiating with legal teams across the world to ensure that local laws are not violated by investments with them.
Decentralized Defi Service Providers
On the other end of the decentralized finance spectrum are stable coins that provide no interest, and just provide the utility of moving money from one location to another quickly. In the middle of this spectrum is open source software managed is a decentralized fashion by teams as Ethereum contracts. These contracts provide both the lenders and borrowers access to loans directly from each other through smart contracts. This arrangement dis-intermediates financial institutions that use leverage to lend more from depositors. Often the lenders while subscribing to the lenders do not provide appropriate support and allow Defi-contract rules to execute as per design. Organizations such as compound.finance, dy.dx, maker etc. operate as decentralized Defi service providers. I have written extensively about the maker protocol and the DAI/MCDAI tokens supported by the blockchain.
Auxilliary Defi Service Provider
There are many auxilliary defi service providers. These service providers range from decentralized anonymous exchanges such as balancer, uniswap, etc. to the creators of stablecoins such as Tether, or USDC. While on one hand balancer, uniswap, etc. operate more as a token exchange system at the protocol layer using Ethereum smart contracts, they are not necessarily interest earning. Often the exchanges that facilitate this function of coin-swap use external oracles to convert the USD equivalent values among the coins to enable an exchange. Stablecoins off late has become a very large investment system in itself – with tether crossing 10Billion dollars in investment and USDC with a market capitalization of 1 Billion Dollars. These stable coins are etherum contracts that ties the issuance of new coins backed by assets whose value are equated to 1 USD. With USDC it is 1 US Dollar in the bank. While stable coins in themselves do not provide interest, a passive investment of stable coin in centralized Defi services provides interest income. The decentralized Defi providers also accept stable coins to facilitate certain functionality.
On the overall, the Defi space is an exceedingly interesting and positive development in the field of finance. However, the excessive interest rates in a market that has shrunk by 30% since its peak is always concerning to users. For example, many centralized Defi services return up to 9% APR which – given the times of COVID-19 seems too high. Another issue here is that of the local lending on the platform. The platforms lend at between 1% APR and 4% APR, but they return 9% APR to their users on stable coins. How is this possible? are they doing something else with our money to get such huge returns? Or are they just turning around new investor money to existing investors? – Only time will tell how this operates. As of now, things seem hunky-dory and people are seeing unheard off returns in this space giving it the necessary thrust needed to survive and excel against all other odds.