The Promise of Decentralised Finance (DeFi)
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Nakamoto famously hated the idea of too-big-to-fail financial institutions and his reference to the article in the Genesis Block’s code is thought by many to have been a declaration—or a manifesto—for how Bitcoin represented the beginning of a more just and incorruptible financial infrastructure that would one day replace the financial institutions that needed public bailouts in 2008 due to their own excessive risk taking.
Some detractors, like Peter Schiff, believe Bitcoin is just a speculative bubble that will inevitably collapse, much like the 1634 to 1637 'Tulip bubble'. Many Bitcoin Maximalists still believe Bitcoin itself will become what Satoshi envisioned—decentralised digital cash—while others now believe that Bitcoin will become more like digital gold and be the world's chosen reserve asset.
Regardless of Bitcoin's future, there is no arguing that it started a decentralised technological movement with thousands of entrepreneurs and engineers using distributed ledger technology (DLT) to try to solve problems born out of centralised system.
The first big innovation in the DLT space was Ethereum, a project that introduced a computational layer to Blockchain and Smart Contracts—executable code that was stored on that blockchain, just like cryptocurrency, and could therefore not be edited once it had been uploaded.
The first popular use-case for Smart Contracts was thanks, in part, to Ethereum's ERC20 smart contract which allowed anyone to mint their own cryptocurrency token on the Ethereum network without having to fork (copy) and/or build and run their own Blockchain.
This use-case was the ICO—Initial Coin Offering—which gave birth to an entirely new way that early-stage startups could raise money, and without having to give up any control in the business via equity. ICO's allowed anyone to buy tokens (usually a fixed or controlled supply) from very early stage crypto projects, anonymously, without needing accredited investor status, and without having to potentially wait a decade before the company goes public or is sold. Projects could raise all of the money they needed without giving up any control, and early buyers received tokens that they could sell whenever they liked.
Buyers could send funds (in the form of Ether—Ethereum's native token) to a public Smart Contract that everyone could examine, that automatically distributed the ICO's tokens to the investor's wallet as soon as the ICO was completed. No middle-man. No broker skimming profits from the deal. Just you, the buyer, getting 100% of the tokens you are purchasing, and the project getting 100% of the funds you are sending.
The ICO was the use-case that popularised tokenisation—a revolution in the way productive value is fractionalised in a secure way and made tradable. This value is typically represented by shares in a corporation that are only available to the public or tradable by early investors, after a corporation has 'gone public', long after it has demonstrated viability. With tokenised crypto projects they are essentially 'public' right from day 1, and the earliest supporters of those projects benefit as much as the founders themselves.
Crypto enthusiasts could enjoy huge portfolios filled with all kinds of super early-stage projects that they really liked, each holding the potential to appreciate tens of thousands of percent if successful. These kinds of opportunities had typically been completely off-limits to 99.9% of people outside of venture capital investment circles.
Thirst for ICOs grew year on year, culminating in over $5.6 billion being raised in 2017.
This explosion in funding was largely fuelled by speculative promise of easy and fast returns. The crypto market was growing steadily in a bull-market that seemed like it was never going to end, and investors could purchase tokens in ICOs and then the price of the tokens would almost always go up when the tokens began being traded on exchanges.
Speculation was rampant, and an ICO bubble began growing.
The huge consumer demand for ICOs to invest in meant that project valuations spiralled out of control. Stories abound of projects raising tens, sometimes hundreds of millions of dollars off the back of a website and short whitepaper.
Then, as 2018 began and the crypto market bull cycle ended, tokens given out to ICO investors began to fall in value when they hit the exchanges, and the ICO market crashed in similar fashion to the 'Dot Com Crash' in the year 2000.
Where many people made a lot of money between Ethereum's ICO in 2014 and the end of 2017… over the following couple of years many people lost a lot money, with some tokens becoming virtually worthless as the market ruthlessly punished purely speculative tokens with no actual utility.
The inclusive nature of token investing that meant anyone could potentially take part in and profit from the success of super early stage projects, ended up being a double edged sword. Those investors who lacked the financial education or experience that would be typical with 'accredited investors' were vulnerable to getting suckered buying tokens from scam projects, or projects with great investor marketing, but no real market viability or token utility.
The explosion of ICOs revealed the huge demand for new avenues through which people could grow their wealth, and after the crash and many investors being burned, it wasn't until decentralised application (DApp) space had progressed further before the next major use-case emerged: DeFi.
One the financial services offered by tradition banks, and one of the primary ways they make a profit from the money they steward, is by lending out that money and charging interest.
This seemingly poor deal for depositors has been an accepted way of doing things because the depositors have enjoyed other benefits, mainly having somewhere safe to store their money which can be accessed through cash-points all across the world, and which they can spend everywhere they go using a bank card. On top of these valuable services, any interest, no matter how tiny, is simply an enjoyed bonus.
In the DeFi space, however, we are seeing the beginnings of a new deal for depositors. Decentralised Lending platforms allow borrowers to borrow a virtually unlimited amount of crypto (depending on how much is locked up in the platform), as long as they can sufficiently collateralise the loan with crypto.
So someone with $1 million of Bitcoin who intends to hold it for the long term could use it as collateral to borrow, let's say $500,000, which he could use to further speculate with other cryptocurrencies, or simply buy more Bitcoin (otherwise known as 'Margin Trading').
The huge innovation with these DeFi lending platforms is that the profits from the accrued interest from these loans does not go to the platform, but to the depositor. The lack of middle man taking profits means that not only can borrowers get better rates than in CeFi, but lenders earn substantially more from their deposits.
Right now, as of writing this, it is possible to stake Stablecoins (and other cryptocurrencies) in DeFi lending platforms and earn a consistent 10-20% APY.
Yet, if you ask 1,000 people on the street if they've heard of DeFi, the odds are that none of them would have any idea what you're talking about, and would likely not believe you if you told them that they could earn such a high interest rate on their wealth.
This shows you how early we are to the DeFi space, and crypto collateralised lending is only the beginning.
If you can only use cryptocurrency as collateral on crypto loans, then the only real use-case for DeFi lending platforms is margin trading where speculators take out short term loans in order to either trade crypto with more leverage, or perhaps to purchase NFTs that can be flipped for a profit.
Your every day borrower, however, will typically want to borrow cash because that is precisely what they don't have. They would typically then provide proof of ownership of other assets to guarantee the loan, like a car or a house. You can't tokenise cars or houses in DeFi—yet—but we see the potential of what is to come in new lending platforms that accept NFT collectibles as collateral for crypto loans.
In the near future it will be possible to tokenise all 'real world property' in the form of NFTs (non-fungible tokens) and use these NFTs as collateral to take out loans on DeFi lending platforms, or use a variety of other financial services.
Tokenisation is set to transform everything we know about value and ownership.
Virtually all of the profit made from lending out money is made by the bank, with a tiny fraction going to the actual owner of the money—the bank customer—with U.S banks offering an average APY of 0.1% ().
The savings account offering the highest APY is Popular Direct Plus, with 2.55% APY, with the lowest being Chase, offering just 0.01% (, ). The average APY for U.S Banks is 0.1% ()
