Last year’s Bitcoin bull run caused even some of its biggest skeptics to soften their stance. From economists to hedge fund managers, the world is opening up to technology, and at the center of that movement is decentralized finance, or DeFi. As the market capitalization of all cryptocurrencies has reached $ 2 trillion, or as much as Apple, it’s the promise of DeFi – a small corner of the blockchain industry today – that is holding the market back. attention from institutional investors.
As Bitcoin’s (BTC) bullish trend persists, interest-bearing crypto products have become all the rage. Some services offer up to 8% return on Bitcoin holdings. For investors who already expect an increase in value, this can be extremely helpful in maintaining cash flow without selling assets.
The three main factors that bolster institutional interest in Bitcoin are the current historically low interest rates, the rate of inflation, and geopolitical instability. With near zero interest rates expected for the foreseeable future, investors are preparing to move their funds to alternative locations to secure their wealth.
The US Federal Reserve’s 2% inflation target has raised concerns among investors fearing a devaluation, and with tensions between the US and China on a precarious edge, US dollar-denominated portfolios are turning down. day by day more risky.
A market for the money
Buying, storing and using cryptocurrencies securely is still quite a complex ordeal – much more complex than setting up a bank account. However, according to Larry Fink, CEO of BlackRock – a global investment management fund with nearly $ 9 trillion in assets under management – Bitcoin could evolve into a global market asset and reach new heights in the years to come. .
In the traditional financial system, money markets are part of the economy that issue short-term funds. They usually process loans for periods of one year or less and offer services such as borrowing and lending, buying and selling, with wholesale being conducted over the counter. Money markets are made up of very liquid short-term assets and are part of the larger system of financial markets.
Money markets are traditionally very complicated, with high overheads and hidden fees that drive most investors to hire a fund manager. However, their existence is essential to the functioning of a modern financial economy. They encourage people to lend money on a short-term basis and to allocate capital for productive use. This improves the overall efficiency of the market while helping financial institutions achieve their goals. Basically, anyone with extra cash can earn interest on deposits.
Money markets are made up of different types of securities, such as short-term treasury bills, certificates of deposit, repurchase agreements, and mutual funds, among others. These funds are usually made up of stocks that cost $ 1.
On the other hand, capital markets are dedicated to trading long-term debt and equity securities and point to the broader stock and bond market. Using a computer, anyone can buy or sell assets in seconds, but companies issuing shares do so to raise funds for longer-term trading. These stocks fluctuate and unlike money market products, they do not have an expiration date.
Since money market investments are virtually risk-free, they often come with low interest rates as well. This means that they won’t produce huge gains or show substantial growth, compared to riskier assets like stocks and bonds.
DeFi against the world?
To hedge against currency risk, institutions have started using Bitcoin and retail investors are following their lead. Over 60% of Bitcoin’s circulating supply has not budged since 2018, and BTC is expected to significantly exceed $ 100,000 over the next 24 months.
If the current trend continues, investors will continue to store BTC. However, while much of the supply of the world’s leading cryptocurrency remains in stock, the DeFi industry is constantly producing alternative platforms for paid payments through smart contracts, increasing the transparency by allowing investors to view and track on-chain funds.
The average return on DeFi products is also much higher than in traditional money markets, with some platforms even offering double-digit annual percentage returns on deposits. From asset management to smart contract auditing, the DeFi space creates a decentralized infrastructure for evolving money markets.
According to Stani Kulechov, co-founder of the Aave DeFi protocol, rates are high during bull markets because funds are used to raise more capital, with the cost of margin driving up returns. “The new innovation in DeFi consumes more stable coins, which further increases the yield. Unless there is a new injection of capital – these rates could stay for a while, ”he said.
The Ethereum network currently hosts most DeFi applications, which has prevented tokens that are not available on the network from participating in decentralized finance. Bitcoin, for example, despite being the largest cryptocurrency in terms of market capitalization, has only recently found its way onto DeFi platforms.
Related: DeFi Yield Farming, Explained
With Kava’s hard protocol, investors can generate a farm using Bitcoin and other non-ERC-20 tokens such as XRP and Binance Coin (BNB). Backed by some prominent names (Ripple, Arrington XRP Capital, and Digital Asset Capital Management, among others), the platforms allow users to stake their cryptocurrencies into a pool of assets, which is loaned to borrowers to earn interest. .
The team also plans to add support for Ethereum-based tokens in the near future. Network upgrade to Kava 5.1, which was postponed to April 8 after failing to meet the required quorum, will also introduce Hard Protocol V2, bringing strong incentive programs and improvements to its governance model.
Most DeFi loans are oversized, which means the pool always has more money than it lends. In the event of a drop in the value of the issued token, the funds of the pool are liquidated to compensate.
According to Anton Bukov, co-founder of decentralized exchange aggregator 1inch, blockchains are the first impartial enforcers in human history – very limited, but ultimately fair – and could provide new services and flows. interactions in the future. “The developers are doing their best to resolve the potential dishonesty issues of existing feeds and invent new feeds by replacing the middleman,” he said.
By creating an automated platform for borrowing and lending assets, decentralized finance enables money markets without intermediaries, custodians, or the high fees that come with high infrastructure costs.
Among the many trends DeFi has set in motion in recent years, yield farming has garnered a lot of attention. Yield farming involves rewarding liquidity providers with tokens that can be invested more in other platforms to generate more liquidity tokens.
Simple in design, Yield Producers are among the most vigilant traders, constantly changing their strategies to maximize their yield and tracking rates across all platforms to ensure they get the best deal. The potential rate of return can get extremely high, but it’s still unclear whether yield farming is just a fad or a phenomenon in the making. Kulechov added:
“Yield farming is simply a way to distribute the power of governance to users and stakeholders. What really matters is whether the product itself would find a market / a good protocol. The most successful governance power distributions with yield agriculture have been with protocols that have found market protocol / adapted prior to such programs. “
Yield Farming has an incredibly positive feedback loop, with an increase in participation increasing the value of its governance token, thus spurring growth. According to Brian Kerr, CEO of Kava, while this feedback loop can produce very positive results in bull markets, it can have totally opposite effects in falling markets:
“It will be up to the governance groups of the different projects to navigate the bear markets effectively, handing over the rewards before a death spiral occurs. Regardless of bullish or bearish markets, yield farming will be a mainstay of blockchain projects for years to come.
Money markets are the backbone of our global financial system, but most of its transactions take place between financial institutions like banks and other businesses in the term deposit markets. However, some of these transactions reach consumers through money market mutual funds and other investment vehicles.
Decentralization is the next frontier for finance, and as top investors continue to engage in the DeFi space, a decentralized economy seems almost inevitable. Participating in the booming environment can be a risky gamble today, but what decentralized financial platforms are learning now will be the foundation for robust DeFi applications of the future. According to Bukov, the higher interest rates of DeFi platforms are “absolutely sustainable”. He added:
“Higher profits are usually associated with higher risks. Thus, the risk-profit model of all these opportunities is always almost balanced. Normalizing the risks would reduce the benefits, as more participants will join together to share the rewards. “
From smart contract malfunctions to the unauthorized withdrawal of community funds, the DeFi space is both a place of miracles and nightmares. DeFi-based yield farming platforms are still in their infancy, and while the numbers can be too tempting at times, it is crucial to do your own research before investing in a platform or platform. active.