Decentralized finance (DeFi) has started to gain a foothold in the talks and has sparked interest. CTF Capital began entering the DeFI world in late 2018 and early 2019. For this reason, Cointelegraph consulted Brian Prilick, CEO of CTF Capital in Spanish, and Lucas Palomeque, analyst and DeFi dealer, who analyzed the issue from Argentina.
Prilick and Palomeque considered the effects that stable coins could have and how this could lead to the creation of their own financial ecosystem in the Ethereum blockchain. They found that one of the most important points for these protocols was the volume “locked” in the protocols, and they started working as market makers for various decentralized exchanges (DEXs). They also dealt with various arbitration procedures to take advantage of possible inefficiencies in the system.
“What we could not have foreseen at the time was the speed at which the market would develop from an unbranded idea that went through different types of denominations to what it is today. DeFi, Decentralized Finance Area that has become a financial and technological innovation factory over the past year from just one player, MakerDAO. Smart contracts with companies looking to leverage the technology behind the Ethereum blockchain to disrupt the financial market, “said Prilick.
Taking into account the events in the market over the past year and a half, they prepared a report with an update of the emerging trends and communicated it to Cointelegraph in Spanish. Here are the key points of this analysis.
Ethereum and smart contracts
“At the beginning of 2019, if there were any doubts about which platform in the smart contract market would take the pulse, it is clear at this point that Ethereum is the only Ethereum killer on the market today. Ethereum is the blockchain platform for intelligent Contracts that do most of the transactions – in fact, we’ve recently managed to break the incredible mark of 100 million active wallets, and this is where all of the DeFi products and applications with real use have chosen to be deployed, ”they said.
“This intensive use has not been without problems. Gas prices have increased exponentially, making the network prohibitively expensive for small businesses and the need to scale the network is growing.” On the other side of the coin, this in turn has resulted in miners generating more transaction fees through the Ethereum network than through the Bitcoin network. The reasons why this network has escalated can be attributed to various factors. “The main components,” they added.
The first one they considered important when talking about any type of blockchain was the community that was created around them and the ease this community could offer to bring new developers and followers to this market. “Ethereum is about technological innovations and new tools that small developers can use to create large products at low cost. The main example is Uniswap, which was developed by a single programmer and today processes hundreds of millions of dollars in volume every month. Because of these possibilities and of technical support, Ethereum has four times more developers than any other blockchain, “they noted. And is it for Prilick and Palomeque that the development of this workforce drives innovation and keeps Ethereum at the top?
On the other hand, they believed that Ethereum also had a pragmatism and functional capacity that enabled him to become the sandbox for testing any type of application, be it financial or organizational. It made it possible to create DAOs and mix them with financial applications. On the one hand, DAOs are experimenting with how to create new types of organizations that are more flexible than traditional companies and attract more and more specialized workers to work in space. On the other hand, financial applications are enabling more and more users to find real use for blockchains, ”they commented.
Stable coins as the most important product in the DeFi ecosystem
For CTF Capital, Ethereum has become the platform of choice for stablecoins, tokens that follow the price of the dollar or another “stable” asset such as gold (e.g. PAX Gold). With stablecoins, users who don’t want to be exposed to the great volatility of cryptocurrencies but want to access financial systems like loans or dollar returns for their assets can do so from anywhere in the world without having to move from your home. “In this credit market, AAVE and Compound are the two platforms that have conquered the market,” they said.
“With the ability for companies to make token creation very easy and make ETH costs“ acceptable ”, the market for stable ETH coins grew from less than $ 1 trillion in 2018 to more than seven billion in this year, which are attracting big players like USDT who have migrated a lot of their tokens to this blockchain, ”they later explained.
For Prilick and Palomeque, the heavy use of this type of currency is one of the factors that have caused network (gas) transaction costs to rise so much over the past year that they have become their ATH (All Time ) were brought high).
The explosion of decentralized exchanges
Regarding DEXs (decentralized exchanges), they cited an article by dydX from CTF Capital that shows the development of the volumes operated in the past 18 months and the appearance of new platforms that have arisen and created interesting traction. The graphic can be seen below:
Development of the decentralized stock exchange market.
In relation to this, they said, “As we can see, the volume has skyrocketed, with more players participating and winning and increasing the volume. In June we saw that the ATH of the volume traded on these exchanges reached $ 1.5 trillion for the first time. It is interesting to note that this volume does not come from new crypto users, but from traders who stop using central platforms and switch to their decentralized counterparts. “And they shared the following graphic from The Block:
This increase in the volume operated in the DEX prompted them to review the main advantages they have over centralized exchanges:
Privacy: A KYC process is not required and therefore does not contain any user data.
Without intermediary: interacts directly with smart contracts and generally the user works directly from his wallet
Decentralized: It works through a series of synchronous nodes. It is not a server that can be hacked or manipulated.
Resistant to censorship: Because it is decentralized, no government or legal person can unsubscribe.
However, they made it clear that not everything is an advantage: “The main drawbacks they have are the lack of liquidity and the speed of the transactions. Even if the volume has grown exponentially, it is far from approaching a volume that can compete with that of the main decentralized exchanges that handle trillions of dollars a day. Transaction speed is a point that has sparked many debates and for which several projects have tried to come up with solutions. Loopring is currently being introduced as one of these alternatives known as Layer 2. However, we see that we are far from achieving a smooth user experience and that the peculiarities of the blockchain also expose users to serious risks. “
In addition, they pointed out that another important innovation is the creation of automated market makers, algorithms that regulate the buying and selling of a liquidity pool and allow any user to get a return on their crypto by using it in their smart “Block” contracts. “This active management of the funds started with the foundation of Uniswap and was consolidated with new projects such as Balancer and Curve. It is an innovation in relation to traditional systems and enables every project, regardless of this, to create its own liquidity pool for its token from an external market maker. Given the development of these protocols, we can see that they were one of the main winners on the market, ”they said.
The birth of profitable agriculture
Interestingly, in CTF Capital’s analysis, they emphasized the importance of memes as a source of information.
“Memes are one of the most important sources of information to understand the development of the market. Recently, a major movement emerged in the major social networks in 2020, which was defined as “income farming” and expressed different ways of achieving returns through market movement, crypto-assets between the different DeFi platforms. Yield farming is a trend that has occurred in the past few months, but it is actually ending something that has been happening for almost a year with the departure of the Compound Ctokens or with the liquidity pools encouraged in Uniswap, Synthetix, perhaps the best player knows how to take advantage of this trend. It is not easy to understand this movement. It’s about understanding blockchain, financial markets, trading algorithms, and finally a business vision. However, the development and complexity of DeFi retailers has brought this type of strategy up to date. Today, the market has grown in volume that until recently was unthinkable for DeFi, ”they emphasized.
According to Prilick and Palomeque, what happened can be divided into three phenomena:
Different interest rates in the system attract different traders. These rates are often high because of the risk of investing capital in a blockchain project and because it is about capturing the volume observed in the market.
The interoperability that occurs between these projects leads to the creation of symbiotic relationships in which the debts in one protocol can be used to generate a return in another protocol, which results in the whole system being in a natural way connected is.
In order to achieve a volume that is above the rates, the projects offer governance tokens with which users can vote on protocol decisions and which in turn are negotiable.
But what is the incentive that drives all of this if there is one? The answer was: “Liquidity, these new projects need to scale quickly, and just as users need them, they need another key component for every financial application, a liquidity pool big enough for products to work smoothly. As this liquidity increases, incentives will decrease and reveal projects that are really useful in the market compared to projects that create a parasitic relationship. “
Yield farming could therefore also be understood as Liquidity mining, Use the network by providing liquidity to projects that need it.
The risks involved in the complexity of this market are at least greater than the opportunities:
Hacking Risks: Smart contracts are still new and therefore experimental technologies, hacking at The DAO in 2016 that led to Ethereum’s diversion, or the latest hack at BZX through the use of various DeFi projects by one hacker are just a few examples .
Financial Risks: The fact that many of these protocols are not fully understood by their users leads to a constant risk that loan collateral is lost in a volatile world and interest rates change from day to day. Newer users are taking senseless risks and waste all their capital
Systemic risks: DeFi copies the good and the bad from the traditional market. The introduction of various income parks has led to systemic risks in the past month, which can even lead to the failure of various systems. One example is the DAI bond, the value of which is beginning to increase due to the demand for use for this type of protocol and which brings the price over a dollar. The interoperability that makes the market strong also means that if one of the big projects fails, its case can affect the whole system, a crypto crisis of 2008 that is more than at stake given the ambitions.
Missing legal systems: There is no Fed to help us or a system to complain if something goes wrong. The crypto space is the financial “wild west” and every investor must be aware of the risks. Beyond everything, this is a risky game.
CTF Capital’s conclusion was as follows: “The pace at which DeFi market capitalization has increased in USD volume blocked from one trillion to two trillion, accompanied by the large number of crypto users that are emerging to think that we are at the beginning of a new trend. Our “more than a trillion market capitalization rule marks a start” was broken in record time.
“The number of new DeFi projects that will compete with the current ones may be comparable to the DotComs bubble, but in the crypto market. It has to be seen whether the market and capital are ready to follow this trend. A decline in traditional markets could become counterproductive for this ecosystem and disrupt the flow of funds that can flow into this area, ”they said.
They also expressed their opinion: “To be realistic, this movement is far from competing with the traditional financial system, and not just because of the volume that moves it. The new tributary of users has exposed the main problems of blockchain, scalability and the lack of legal clarity to which users are exposed. If the Ethereum doesn’t raise prices, it’s unaffordable for retail investors, and the dream of providing a financial system that reaches everyone will be just that, a dream. This is happening at a time when other players are trying to dethrone Ethereum using other technologies, and now for the first time with a clear roadmap of which financial products can be created on these systems. “
“The fact that there is a lack of legal certainty will continue to deter institutional actors who cannot risk losing money due to one of these mistakes. We hope that projects offering insurance for this system, such as Nexus Mutual or Opyn, will grow this year, and on the other hand, projects like Kleros, to create a certain legal framework, can finally start with a clear need from the EU users . Still, the potential is in sight and there is no denying that the Ethereum community is the most innovative today, and new users who are increasingly encouraged to become involved in the system can become one of the companies driving new forces the system ahead. We look forward to the near future to see how the ecosystem develops, “they concluded.
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