What Is The Future For Decentralized Finance (DeFi)?
Hello everyone, and welcome to this new Bitget Academy article.
Decentralized finance (DeFi) is becoming popular, especially among institutions. A good example occurred recently with MakerDAO, which has approved a $100 million stablecoin loan vault for a 151-year-old US bank, Huntingdon Valley Bank. At launch, the vault will have a debt ceiling of $100 million, which will later be raised to $1 billion. This institution is substantial, and so are the numbers. Thus, it seems important to us to understand the future for the DeFi.
What is a decentralized financial protocol?
MakerDAO is known as "the decentralized central bank," local crypto anti-Christine Lagarde. What is exciting about MakerDAO is that all active members have different visions, and the combination of these visions forges MakerDAO today. MakerDAO is in the business of unregulated banking. We could define DeFi this way too. What we mean is issuing tokens, especially stablecoins, and using them to issue loans.
Then, once this is done, it is necessary to optimize these processes. This is why many DeFi protocols seek to secure these tokens and bring maximum stability. Stability is often a matter of balancing the pros and cons. It's entirely possible to be super stable, but that comes with consequences like holding USDCs or other stablecoins often issued by highly centralized organizations. Some may prefer less stable tokens.
DeFi protocols seek to improve the efficiency of these crypto assets. So, for example, if you have ETH, you can deposit it on a DeFi protocol like MakerDAO, which will create a stablecoin, the DAI, which will track the doll ar price in order to lend that DAI and get a return.
MakerDAO, which we have used as an example in this article and will continue to describe, is one of the most decentralized protocols and one of the oldest. Of course, there are dozens or even hundreds of others, so as usual, we invite you to do your own research on the subject.
MakerDAO allows anyone to come to their forum to make a proposal. Obviously, there are social rules which mean that if someone comes to ask for 10 million DAI without anything in return, it will not pass. The more time passes, the more complicated the system becomes. In 2020 it was even simpler because the vaults were only on Ethereum, but now there are many vaults and many systems that all differ more or less from each other. It is more complex, there are a lot of activities and a lot of micro-management, but we recommend that you only focus on certain projects because anyone can make a difference. To simplify, if you have an idea, you can submit it, and if it is voted, it is implemented. As with any work, there are limitations in terms of the load that the developers can bear, it is also necessary to take into account the legal aspects, which require a lot of time and money. So it's not possible to do everything, but if you are motivated, DeFi represents an excellent opportunity.
DeFi is much more risky than traditional finance
Would significant cascading liquidations on Ethereum these days have an impact or not? This is an open question because we have never experienced it. Finally, the price of Ethereum seems to be quite efficient in the sense that it has never varied by more or less 50% in one hour. So for the moment, we are touching wood, we will say. Since March 2020, which was the black swan and the big COVID-19 week with all the lockdown announcements, many protocols have exploded mid-air, but others have held up. We can mention Compound, Aave, and a few others that prove that decentralized finance is robust but has limits.
A good example is Celsius Network (CEL), which announced on July 13 that it filed for Chapter 11 bankruptcy after a month of turmoil and after freezing customer accounts. Court filings show that Celsius is around $1.2 billion in the red, with $5.5 billion in liabilities and $4.3 billion. It also looks like customers may bear the brunt of Celsius’ collapse, as the filings show that most of the liabilities, $4.7 billion, represent customer holdings. "I have been saving for years to amass the sum that I had in Celsius," Mario Foti says he was a disabled Afghanistan war veteran. "This is gross negligence and a complete disrespect to the people that have lost their livelihoods over this. I pray the justice system does its job and does not allow the rich to continue stealing from the poor."
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DeFi has made and will continue to make giant steps forward.
A few years ago, it wasn't easy to imagine that DeFi would take such an essential place.
Today, there are some super interesting projects, and the advantage of DeFi is that the barrier to entry for new members is very low. Indeed, you just have to register on the forums and other communities of your favorite protocols in order to interact and potentially work on more or less important topics. DeFi really exploded into the public eye in the summer of 2020 and has grown from roughly $500 million TVL (total value of cryptocurrency locked in a smart contract) to over $58 billion today:
That's pretty huge, and it's still going on. However, many people still fail to consult the governance forums where sometimes there is a lot of information, and it is also occasionally possible to take part in the protocol.
“On-chain governance is a system for managing and implementing changes to cryptocurrency blockchains. In this type of governance, rules for instituting changes are encoded into the blockchain protocol. Developers propose changes through code updates, and each node votes on whether to accept or reject the proposed change.” - Source: investopedia.com
Imagine the future of DeFi
Last year, at equivalent risks, DeFi was bringing in much more than traditional finance, and now it's the opposite. We can imagine that in the future, everything will be tokenized, and therefore stocks, real estate, bonds, ETF, etc... everything will be on a blockchain, so eventually, oracles such as Chainlink will be needed to verify certain information. So there is a big interest from traditional finance players to access DeFi products, but there is also a huge attraction for traditional finance products to DeFi players. As you can see, the future of DeFi depends on a centralized/decentralized marriage that goes well and lasts. Without this, it will be impossible to build a solid foundation. These institutions, unlike individuals, have billions and billions of assets under management.
During the summer of 2021, many institutions were interested in DeFi. Moreover, we have noticed that they have often recruited "Head of Digital Assets" type people who work on crypto topics. DeFi allows these institutions to issue multi-million dollar bonds and to secure them at a very high level, as some are rated AAA by the rating agencies. This allows them to borrow cryptocurrencies by depositing DeFi vaults on these bonds. There is the whole legal aspect which is very complex because according to the countries and the laws, there is to summarize the need to secure the operations, and that can be done in particular via security agents. Sometimes operations can also be completely off-chain as institutions may have a pool of loans and may allocate interests in that pool of loans to the decentralized entities in order to spread risk and reward.
That said, decentralized finance is not 100% clear on its purpose, and building it will take time. There are a lot of regulatory issues to be resolved, especially at the level of decentralized entities, because the question of liability arises. That said, there are dozens and dozens of teams working on serious projects, some of which are not public, and the fact that regulated banks can do business with decentralized entities gives positive signals regularly to the cryptocurrency market and especially accelerates DeFi adoption.
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Disclaimer: This article is for educational purposes only and is not intended as investment advice. Qualified professionals should be consulted prior to making financial decisions.
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