Financial Inclusion write on book isolated on wooden table. Medical or Finance concept
The Future of Finance is Fast Forming With Decentralized Finance (DeFi) As a Fundamental Pillar
The past year has been pretty eventful for the crypto ecosystem following the debut of Decentralized Finance (DeFi). This nascent niche is gaining traction beyond the crypto community, with institutional investors eyeing a piece of the cake. However, not everyone is on board; some traditional finance stakeholders, including U.S regulators, have reservations.
That said, we cannot ignore the fact that DeFi challenges the long-standing centralized architectures favoring big players, leaving most people at the mercy of meager interest rates. With DeFi, the situation is different; this ecosystem introduces a decentralized financial market where anyone globally can participate.
At the core, DeFi eliminates middlemen such as bankers and investment firms. The value proposition of this ecosystem has seen it rise the ranks to a total value locked (TVL) of $83 billion as of press time. Going by the sentiments, DeFi enthusiasts are optimistic that it is just the beginning of a new era in finance.
The Grass is Greener in DeFi
While some stakeholders may beg to differ, the opportunities in DeFi are in tune with the narrative of a futuristic financial ecosystem. Today, there are several ways in which anyone can contribute to the growth of the DeFi ecosystem. Even better, most of these opportunities offer early DeFi adopters a passive way to generate income.
Let’s delve into some of the ways in which one can contribute to the growth of DeFi while earning a passive income. But before that, it is noteworthy that the DeFi opportunities highlighted in the next section do not guarantee a passive income. Instead, they paint a picture of the developments in DeFi.
Decentralized exchanges (DEXs) such as Sushiswap and Uniswap depend on liquidity providers to enable token swapping within their platforms. Ideally, DeFi users pool liquidity by dedicating their tokens towards a particular pool in return for a percentage of the transaction fee on all swaps. For instance, liquidity providers on Uniswap earn a 0.3% commission on all transactions, which is distributed as per one’s share in the pool.
Notably, becoming a liquidity provider does not guarantee profits. In some cases, DeFi users providing liquidity have ended up with worthless tokens due to impermanent loss (IL). Simply put, IL occurs when the ratio of liquidity pool tokens becomes uneven, an eventuality that is possible if one of the LP tokens loses significant value.
Besides becoming an LP, DeFi users can further lock their LP tokens in yield farms to generate more passive income. Yield farming became popular at the debut of DeFi governance tokens led by Compound (COMP). This lending & borrowing DeFi protocol was among the pioneer players to feature yield farms for users to unlock more governance tokens. Today, the trend is almost standard in the DeFi ecosystem, with some of the new projects launching yield farms offering 100% APY and above.
However, just like LPing, yield farms carry a significant technical risk. Some of these upcoming yield farms have exposed users to massive losses as a result of ‘rug pulling’. A situation where DeFi users are lured into ‘promising’ projects and later left with worthless tokens once the project developers withdraw liquidity.
Staking is another way that DeFi users can contribute to its growth while earning a passive income. This form of participation is much more straightforward. DeFi participants only need to lock their tokens to support the operations of a particular blockchain, mostly proof-of-stake (PoS) projects such as Ethereum. Staking enhances blockchain operations by allowing more users to dedicate their tokens towards transaction validation and network security.
As for passive income, staking offers a more significant ROI than traditional savings accounts or other legacy investments. Upcoming DeFi staking platforms such as YeFi.one feature an opportunity to stake its native token ‘YeFi’ and other digital assets, offering users up to 80% APY. This open-source DeFi protocol can be accessed through Binance Smart Chain (BSC) compatible wallets.
Unlike traditional savings accounts, DeFi staking platforms such as YeFi.one offer users more flexibility. This platform gives an option to stake one’s crypto assets for one day or fifteen days while also featuring an auto-renewal function.
Lending & Borrowing
Like traditional banks’ lending services, DeFi features lending and borrowing protocols where users can access liquidity or lend their funds for a better ROI. As it stands, Aave is the leading DeFi lending platform with a TVL of $15 billion.
The process of lending and borrowing through DeFi protocols is dependent on smart contract automation, which means that no intermediary is involved. Instead, DeFi users can deposit their stablecoins or other accepted crypto assets on a platform such as Compound, which currently offers an APY of 2.7% for lending DAI while the borrow rates are currently at 4.32% APY.
While DeFi may still be in its early stages, the future of finance is fast forming. This can be seen in rising interest by financial institutions, including big banks such as JP Morgan and Goldman Sachs. The latter recently filed for a DeFi ETF to expose more public companies to blockchain and DeFi innovations.
According to the filing, Goldman Sachs intends to introduce a DeFi index that will meet the needs of institutional investors,
“The Index is designed to deliver exposure to companies that are aligned with two key themes, the implementation of Blockchain Technology and the Digitalization of Finance (the “Themes”),”
Per the trends, it seems that the mainstream adoption of DeFi is within the horizon and could come sooner than most stakeholders expect. However, the technical and legal uncertainties facing DeFi still pose a significant challenge to its growth.