Thursday 10 December 2020 9:00 am

Definitely DeFi

2020 has been a year of spectacular growth in the decentralised finance (DeFi) arena. 

From retail crypto enthusiasts diving in head-first, to institutional investors cautiously dipping their toes in – the blockchain-powered space of DeFi is flourishing. Since the start of the year, the amount of money locked in DeFi protocols has skyrocketed by a staggering 2,000%. 

Impressive as that may sound, the $14 billion DeFi ecosystem pales in comparison to the trillion of dollars in traditional finance. But given the industry’s breakneck rate of growth and its ability to deliver hearty investment returns in a low-interest rate environment, the sector looks set to continue pulling serious money from traditional finance.

Current use cases of DeFi

Broadly speaking, DeFi promises a sophisticated, futuristic alternative to traditional finance. 

At its core, it is a system of financial products and services that run on open-source networks and do not rely on any centralised institutions, like a bank. Decentralisation means that DeFi services can be accessed worldwide 24/7, opening up access to financial tools to anyone, anywhere globally and without any middlemen. Its possibilities are seemingly endless.

DeFi lending protocols, such as Aave, allow people to earn interest on their cryptographic deposits and borrow assets. Loans are automatically negotiated by a system of smart contracts on the blockchain. These lending protocols determine interest rates for depositors based on the liquidity supply and borrowing demand. DeFi rates for depositors have been historically higher than lending rates in traditional banks, making DeFi an even more attractive, compelling choice for those looking to maximize their passive income. 

DeFi is permissionless, so barriers to entry for traditional financial services, such as credit checks, are removed. You will never even need to KYC or disclose your identity when using a DeFi protocol, because the whole system is trustless. Loans are arranged automatically, so lenders and borrowers can be total strangers. Unlike the traditional financial system, data is stored publicly on the blockchain, so DeFi is completely transparent. 

Additionally, DeFi services are non-custodial. This means that when you deposit your assets to a lending protocol, such as Aave, you remain in full control of your funds and you can use them however and whenever you want. However, this is not without its risks, as you bear full responsibility for your funds. If you forget the passphrase for your cryptocurrency wallet, for example, there is no centralised institution that can help you login or return your funds. 

Overcoming obstacles to institutional adoption

Last week, Copper announced the launch of a new tool to securely connect institutions to the emergent world of DeFi and ensure they don’t get left out in the cold. 

CopperConnect is a resilient, tamperproof browser extension that provides optimised security throughout the custody, transfer and lock-up process as an asset makes its way to a DeFi smart contract. The browser extension works to connect Copper’s multi-party computation (MPC) custody system to both centralised exchanges and DeFi apps.

The emergence of new, innovative products such as CopperConnect that eliminate many of DeFi’s inherent risks, are setting the conditions for forward-thinking, institutional investors to finally participate in earnest in this burgeoning market. 

Though it is too early to determine when DeFi will begin clawing notable market share from existing traditional financial incumbents, with 2021 right around the corner – there’s no better time to put our fortune teller hats on and gaze into the crystal ball. 

We expect that once DeFi evolves further and achieves broader adoption, traditional institutions will launch their own offerings that leverage DeFi technology – similarly to what we’ve already seen with JP Morgan Coin for digital payments. 

We also anticipate the space will enter an era of increased focus from venture capital. Earlier this year, Silicon Valley powerhouse Andreessen Horowitz (a16z) doubled down on its commitment to digital assets with a second crypto fund specifically looking into projects touching DeFi. In Europe, many of the continent’s largest funds – including Creandum, Octopus Ventures and Index Ventures, have also started to proactively engage with the DeFi ecosystem. There have also been an abundance of specialised DeFi-focused VCs, such as Blockchain Ventures, Fabric Ventures and Outlier Ventures, emerging across Europe. All this investment is likely to beget even more new growth.

Finally, as the markets mature and larger amounts are transacted in DeFi, regulators must collaborate with public and private institutions to keep the markets safe and protect investors from fraud. This is critical for the long-term success of DeFi.

In closing, the rapidly evolving nature of DeFi is the very thing that makes the future difficult to predict (even in the short-term). Owing to the sector’s nascency, many of the current obstacles to adoption may be mitigated as DeFi matures. For now, a host of promising, dynamic solutions are already on the way, making 2021 an undoubtedly exciting year to follow. *Virtual toast*

Dmitry Tokarev, Founder and CEO – Copper & Stani Kulechov, Founder and CEO – Aave