The Blockchain 10 Part Series: Episode 7, Why DeFi 2.0 is Exciting

Financial markets have been around for a long time, with the earliest bank being formed around 2000 BC. People deposit money at banks and receive interest.



Financial markets have been around for a long time, with the earliest bank being formed around 2000 BC. People deposit money at banks and receive interest.

Banks then use this money to lend to people who pay a higher rate of interest. More complexity has arisen over the centuries and there are now many exotic financial products from credit-default swaps to futures. Some products are for businesses, others for consumers. Fundamentally, they are all about offering different levels of return for different levels of risk.

Decentralised finance or DeFi has the same objectives - maximising returns for investors. However, it’s about maximising returns for all investors, not middlemen like banks. It does this by allowing anyone in the world to lend, borrow or trade blockchain-based assets at any time. In decentralised finance, an online wallet in Kenya can borrow money from a protocol in America, with no identity checks or credit score applications. The rules of the applications are the same for everyone.

The first wave of DeFi applications occurred in early 2019. In DeFi 1.0, most basic financial products were copied over from traditional finance. Borrowing and lending were first on the list. People could borrow cryptocurrency from lenders like Compound without having to reveal their identity. However, borrowers had to over-collateralise the loans often providing five times the amount they borrowed. If the value of a cryptocurrency suddenly dropped causing the collateral’s value to drop past a certain point, it would be automatically liquidated to cover the cost of the loan. Pretty tough way of doing business!

For all its shortcomings, it was nothing short of ground-breaking. The role of a bank had been replaced by code. More and more financial products were offered, mostly built on the Ethereum ecosystem. There were decentralised exchanges like Uniswap. Then there were options and futures from companies like DyDx. Then prediction markets like Polymarket.

A key innovation of DeFi 1.0 was the idea of liquidity pools. Instead of having to rely on a market maker to match buyers and sellers, people could be rewarded for locking their assets into a pool. This pool of assets means there is instant liquidity for trades. Smart contracts can then automatically move money between parties. It cuts out the middleman. To illustrate this point, if I wanted to buy $1 million Nigerian Naira, there may not be many sellers readily available. I could only buy when the exchange finds a seller willing to pay a price that I am comfortable with. But if there is already $3 million Naira locked, a smart contract can automatically execute the contract and provide me with the funds in exchange for the Aussie dollar. It’s fast and permissionless.

DeFi 2.0

While most of these DeFi 1.0 companies are still around and thriving, a new wave of companies has emerged post-2020. We have arrived at the next evolution of decentralised finance, DeFi 2.0.

In DeFi 2.0, new financial products that never existed in traditional finance are being created. They are also being built on entirely new blockchains such as Solana, Avalanche & Fantom. In addition to new products, many of traditional finance’s more exotic financial products are also being recreated on the blockchain. Decentralised financial markets are becoming more complex.

For example, the interest you receive in exchange for providing liquidity (LP Token) can be used as collateral or even used to get interest on top of that interest. Examples of such protocols are Abracadabra and Popsicle Finance. There are now also increasingly complex financial products like synthetic assets. Synthetix is a company that mirror equities on the blockchain. You can then take positions based on the value of the stock. Do you think the stock will go up or down? Effectively, they are fake versions of stocks like Tesla, Apple and Netflix but reflect the exact price of these real-world assets.

Another key innovation in DeFi 2.0 is the rise of non-pegged stablecoins. A stablecoin is a coin that's price does not fluctuate relative to something we care about. Most stablecoins are usually pegged to the dollar, where a dollar of collateral will be taken in exchange for one stablecoin. This allows coins to be used as a reliable medium of exchange. No one would use bitcoin to buy a car if the price could up 50% in a day. However, innovation in DeFi has seen the creation of stablecoins that are not pegged to any fiat currency and use algorithms to have a stable price, see the Float Protocol.

It can all be a lot to take in. Fundamentally, economists, developers and traders are having a lot of fun experimenting with programmable money.

We believe there is a lot more to go. In particular, we are excited about:

Collateralisation of loans with digital property such as NFTs

  • Fixed interest rate loans

  • Real time payroll

  • Options and future trading on Solana

  • Stablecoins for international remittance

  • And more…

How Do I Participate?

To enter the DeFi world, you must go through a centralised exchange first (Binance, Coinbase, Etoro). This is Layer 4. A centralised exchange is where fiat currency is converted into cryptocurrency. You are required by law, to enter your identity information. Once crypto has been acquired, users can go to decentralised exchanges or other decentralised financial applications. This is Layer 3.

It’s like arriving at an Airport where your identity is checked and then flying to a remote island where you can then go wherever you want but to come home you have to again go through airport security. To enter DeFi, you have to go to the airport (Binance, Coinbase, rToro) but once this is done you can go anywhere in DeFi land without showing your identity (Fantom, Olympus, Uniswap).


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