The amount of staking assets (TVL, Total Value Locked) in DeFi has increased more than 40 times, from $1 billion to $41 billion now (Feb. 21’).
DeFi presents a new alternative to existing financial systems (CeFi, centralized financial). What happened to GameStop and Robinhood recently has shown a decline in reliability of and the possibility of development of the DeFi which ensures both transparency and fairness.
In this article, we will take a look at key components of DeFi ecosystem and major DeFi projects.
As you can see from the fact that all three top projects with the largest TVL in DeFi are lending platforms, the lending service is currently the most active service in the DeFi market. DeFi lending platforms offer loans without intermediaries and allow users to enlist their crypto coins on the platform for lending purposes. Besides, DeFi lending protocol enable lender to earn interest on supplied stablecoins (e.g. DAI, USDT) and cryptocurrencies (e.g. BTC, ETH). Defi lending is the most prevalent contributor for locking cryptocurrencies.
The Maker Protocol, one of the largest decentralized applications (DApps), was the first DeFi application to earn significant adoption. Maker allows users to borrow against a variety of supported crypto assets as collateral that they deposit into smart contracts. When users seek to borrow through the MakerDAO platform, they deposit supported cryptocurrencies as collateral and receive their loans in DAI. When a user wants to borrow DAI, they deposit ETH or other collateral asset into the Maker Protocol and receive a loan relative to their collateral. The loaned DAI can be paid back at any time in return for the collateral or alternatively, if the value of ETH drops, the liquidation process will be carried out. However, when they are paid back, DAI tokens are automatically destroyed. The entire process of taking out a loan, paying off, and liquidating is programmed.
Decentralized Exchange (DEX)
DEX(Decentralized Exchange) is a DeFi service following lending services. DEX is a peer-to-peer (P2P) marketplace that enables the trading of tokens through automated processes. The centralized exchanges are not truly anonymous since they store personal data of individual investors on exchanges as well as private keys in hot wallets. However, DEX only mediates transactions between users, so that users can be assured from the low risk of hacking. It is also possible to make transactions such as virtual asset tradings or loans between individuals which cannot be done on the centralized exchange. Therefore, the demand for DEX is gradually increasing, since it can solve security, transparency, and efficiency problems of centralized system.
Uniswap, which once occupies more than 63% of the DEX market share, introduced an automated model based on AMM (Automated Market Maker), and the price of tokens is determined by the quantity of Ethereum and tokens in the liquidity pool. The difference from the previous exchanges is that there is no order-book system. If a user “swap”s, the buying/selling is made immediately. In other words, there is no process of finding buyer/seller to do transaction with, and the transaction is made immediately regardless of whether the transaction volume is low. As Uniswap has succeeded with this innovative operating system, a number of Uniswap models are emerging.
As the DeFi market grows, it is expected that the decentralized exchange will continue to grow. The Financial Action Task Force (FATF) announced a “Travel Rule” in its recommendations that requires Virtual Asset Service Providers (VASPs) to transmit transactions and customer details to the next institution for certain transmittals of funds. If only the platform for P2P transactions is provided, such as DEX which only provides the trading platform, it is not considered as a VASP. However, due to the nature of the decentralized exchange, that transactions can be made without any identification, future FATF sanctions may be a risk factor.
Since virtual assets generally have a large price volatility, there was a great concern about whether virtual assets could play the role of “currency”. If foreign transactions such as exports and remittances are not affected by high volatility and fees due to differences in exchange rates over time, cryptocurrency can be used more widely because safer transactions can be made. Stablecoin has introduced to the market for this purpose. There are three types of stablecoins; 1) Fiat-Collateralized Stablecoins, 2) Crypto-Collateralized Stablecoins, 3) Non-Collateralized Stablecoins. The representative stablecoins are USDT(Tether), USDC, and DAI issued by Maker Dao, and they are linked 1:1 to the US dollar.
Stablecoin is expected to solidify its role and position as a key currency in the virtual asset market as the size of the DeFi grows. In addition, as the Office of the Comptroller of the Currency (OCC) allowed commercial banks in the U.S. to issue and use stablecoins as a means of payment, the expansion of stablecoins is expected to continue.
In Korea, Lambda256 provides solutions to IDRT’s Rupiah-based stablecoin project in Indonesia, and also to Gluwa which issues fiat-backed token that pegged 1:1 to a target fiat currency. These projects addressed high gas fee for Ethereum transactions and scalability problems through Luniverse solution.
Beyond stablecoins, it continues to bring assets such as stocks, bonds, and real estate in traditional capital markets into the DeFi ecosystem. A typical way to introduce assets in traditional capital markets to DeFi is “Synthetic Assets”. Synthetic asset is an aggregation of securities or assets that only follows the real price of the asset. It produces the same financial results without having to hold the underlying asset.
Synthetix is the most representative synthetic asset protocol. It is a platform for trading and issuing Ethereum-based synthetic assets, allowing users to exchange Synthetix asset, Synth, through smart contracts without any counterparty. As of January 2021, Synthetix has a total supply of more than $100 million in sUSD, and synthetic assets worth $250 million are in circulation.
Asset tokenization has the potential to bring trillions of dollars of real-world assets into the blockchain.
In the process of asset tokenization such as real assets and financial products, it is important to supply reliable data stably. As we’ve seen above, DeFi is operated by programmed systems. However, blockchain network and smart contracts do not reflect the data flow of external networks themselves. Therefore, the blockchain network must be connected to external networks, and the actual application of smart contracts relies on data from feeds or APIs outside the blockchain. Oracle is as a bridge to connect the blockchain network and the external network.
Chainlink is a middleware platform for solving oracle problems, which aims to achieve a real world system with properties as close as possible to those of Oracle under realistic trust assumptions. Chainlink differs from other oracle solutions in that it has a completely decentralized network. It increases the reliability of data by using the average value of data or removing outliers, and helps smart contracts operate ideally. Moreover, a plurality of nodes provides data, thereby reducing Single Point of Failure (SPoF) and improving data reliability.
No matter how innovative the smart contracts of blockchain is, they themselves cannot interact with external resources. In other words, oracle is necessary to access tdata feeds, APIS, and existing bank payment systems. Therefore, oracle is expected to act as a catalyst for future activation of the DeFi in the future.
In DeFi, services such as loans, deposits, transactions, funding, and insurance exist separately, but eventually they are connected to each other. Just as various transactions occur because loans are available, and deposits and interest have occurred because transactions are made.
As we have seen in this article, DeFi is now creating its own services beyond the services provided by the existing financial system. It is hard to predict how much grower the DeFi service, but it is clear that the DeFi market is drawing attention recently. Although there is not much demand for DeFi in real life yet, there is a high expectation that it will expand to many financial fields such as asset management, derivatives, and insurance. Also, there is a possibility to replace much of traditional financial institutions. In the future, new DeFi services will continue to emerge as DeFi services are connected increasingly. This is why we should all pay attention to how the DeFi market will flow.