Last updated on September 4th, 2020
It’s apparent to most of us now that DeFi is a model that investor like, a lot. They like the ability to control their own finances; they like the ability to deal on a level playing field with other investors; they value privacy and lack of censorship that non-custodial finance brings them.
Above all they trust smart contract code over middlemen and centralized agents any day of the week.
With the DeFi movement in full flow, here are a few altcoins that may benefit from this financial revolution.
Top of the list of DeFi players has to be Ethereum. Ethereum is presently the number two cryptocurrency asset by market cap, just behind Bitcoin. In 2009, Bitcoin was ground-breaking with its use of blockchain technology to host a native digital cryptocurrency, namely the Bitcoin token.
Ethereum went beyond this, extending the idea of blockchain to allow any developer to host their own apps and run smart contracts inside its ecosystem. This made it relatively easy for new blockchain startups to use Ethereum as a launchpad for their own projects.
Why is Ethereum crucial to DeFi? At present, Ethereum is the biggest platform for running DeFi projects, by a long way. It has first mover advantage. Whilst there are other smart contract platforms around, namely Cardano, Tezos, Neo, Tron and others, they are not as established as Ethereum and don’t yet have Ethereum’s network effect.
Simply put, developers trust Ethereum because of its track record and network size. In the blockchain world, network size is synonymous with security. Hence most DeFi innovation is taking place on Ethereum. It has become the go to place for launching new DApps (Decentralized Apps).
So how does Ethereum benefit from this new DeFi craze? Basically speaking, Ethereum charges fees for the use of its network. This is the gas fee. This fee is paid by the DApp users whenever they want to carry out an action that involves for example, executing smart contract code, or moving assets around the network. Gas is paid in ETH, so this generates demand for ETH as the DeFi ecosystem continues to expand.
Chainlink has been quietly creeping up the cryptocurrency rankings for some time now. Much of this growth has to do with the explosion of DeFi. Chainlink can be thought of as a utility provider to the DeFi sector. Much like providers of water or electricity are essential to factories making physical products, so Chainlink is essential to lubricating the wheels of the DeFi sector.
What exactly does Chainlink do? In technical speak, Chainlink is a decentralized oracle. It provides the critical link between blockchains and real world data, also known as off-chain data.
Blockchains live in their own separate information silos, whereby only data created on the chain is known and verifiable by the consensus mechanism.
Chainlink is crucial to the operations of most DApps because it provides access to reliable, real world information like stock prices, exchange rates and so on, that is not native to the requesting blockchain.
And for DApps, which live in a common financial ecosystem, access to reliable, timely, and trusted off chain data is critical to their success and therefore adoption.
How does it work? Chainlink’s data comes from node operators, and much like mining or staking anyone can fulfil this role. Chainlink uses a reputation system. The greater the value of the data provided, the higher amount of LINK tokens a node operator needs to stake in order to supply that data.
Node operators that stake larger amounts of LINK tokens will be rewarded with more valuable data requests, and so will earn more staking rewards in return. On the flip side, nodes that provide bad data are punished with forfeiture of some of their staked tokens.
Why is Chainlink crucial to DeFi? DeFi apps cannot exist in a vacuum. They need to bring in data from the outside world. This is where Chainlink comes in. Chainlink’s reputation system means that the greater the demand for data, and the greater the value of that data, the more demand there will be for LINK tokens. Chainlink is likely to grow and benefit from the adoption of DeFi.
Like Chainlink, Ren is a utility network, and not a DeFi application in its own right. RenVM, the Ren Virtual Machine, is about transfer of value from one blockchain to another. This is another critical function of DeFi.
With RenVM, DeFi apps will benefit from more liquidity because it allows tokens of non-native blockchains, BTC for example, to be brought into the Ethereum DeFi ecosystem.
As stated above, blockchains are separate data silos, therefore when they bring in data (or assets) from outside, that has to be done in a secure and trust less way to maintain the integrity of the blockchain.
RenVM acts as a decentralized custodian of digital assets. This enables interoperability between different blockchains. In RenVM’s words interoperability is the ability to transfer assets from one chain to another for use in any application.
Take Bitcoin as an example. Bitcoin lives inside its own ecosystem, and therefore all of the value of BTC is locked up inside that network. How then can someone use their BTC assets within a DeFi app that runs on Ethereum?
Existing solutions to this problem have weaknesses such as the need for a trusted centralized custodian. This clearly isn’t compatible with DeFi.
RenVM’s solution is to replace the centralized custodian with a decentralized custodian that is entirely algorithmic. This is done in a way that is largely transparent to the end user, making the experience far simpler than other solutions.
The RenVM network consists of thousands of independent nodes, called darknodes, which each have to stake 100REN tokens to participate. The bond is there to incentivize good behaviour and punish bad.
Why is Ren crucial to DeFi? Ren adds a significant layer of liquidity to DeFi apps. It allows the transfer of value from one blockchain to another in a seamless way, thus allowing users with non Ethereum tokens to participate in DeFi.
For each token transfer, a darknode is rewarded with a percentage of the transfer value. More value transfer creates more demand for REN tokens, because the rewards increase, as the DeFi wave grows.
Aave is s DeFi money market utility that other app builders can use. It describes itself as an open source non-custodial protocol for lending and borrowing. Aave does not rely on a trusted third party to act as middleman. It is a fully decentralized marketplace. Lenders deposit funds to provide liquidity. From that they can earn a passive income. On the other side, borrowers who want access to funds can do so by depositing collateral.
According to DeFi pulse, Aave has the most assets under management, with a locked in total of over $1.5 billion at time of writing.
Aave plans to extend this model to cater to other tokenized securities like mortgages. Such moves could vastly extend the reach of DeFi into mainstream finance.
Polkadot is a project with the ambitious purpose of being a platform for the next generation of the internet, Web 3.0. At the heart of Polkadot is interoperability.
Polkadot has seen the sticking points of scalability and interoperability that have held back other cryptocurrency platforms, like Ethereum, and is seeking to address that within a unified framework. Its goal is to allow exchange of tokens and data between different blockchains.
In other words, Polkadot aims to be a general network on which other blockchains can connect and interact with one another.
Is Polkadot critical to DeFi? Not at present, but if it fulfils its goals it could be an important alternative to existing platforms like Ethereum.
What’s abundantly clear is that DeFi is evolving rapidly and it won’t wait for anyone. If the current scalability issues are not addressed, e.g. with Ethereum 2.0, we could see new DeFi projects choosing Polkadot as the platform of choice.