Under the hood, DeFi differs significantly from traditional finance. In Part Two, we dive into the landscape of protocols and products in DeFi.
For more analysis of the developments in DeFi over the past year, download our full report, "Decentralised Finance: Usecases & Risks for Mass Adoption".
When my interest and knowledge of the stock market crossed an invisible threshold pushing me to want to invest for the first time, I was unsure where to start. There were the platforms I saw advertised on TV -- Fidelity, Charles Schwab, E-Trade. But I was young, barely 16 years-old, and only had what amounted to spare change from summer jobs; in the most basic bank account possible at the local credit union. I knew the on-ramps, but was a novice when it came to accessing, onboarding, and executing. This story sounds familiar to many individuals interested in DeFi.
For the DeFi ecosystem, on-ramps can mean decentralised exchanges, such as Uniswap or SushiSwap, or centralised exchanges, such as Coinbase or Kraken. Once there, accessing, onboarding, and executing strategies in the diverse and intricate DeFi ecosystem requires a deeper knowledge of the products and protocols. It is not as easy as signing up for Charles Schwab: link your bank account and then you are ready to trade equities or commodities on exchanges around the world -- as my 16 year-old self did. I still have that $30 of APPL.
Below we will dive into the landscape of protocols and products in DeFi.
Blockchain networks such as Ethereum, Tezos, Solana, or Algorand -- to name a few -- support the base layers of the DeFi ecosystem. These networks support openly accessible smart contracts that operate in a variety of ways. For example, the lending protocol Compound uses ERC-20 tokens known as cTokens to tokenize ETH that is deposited into the corresponding Compound smart contract. All Compound products live on the Ethereum blockchain and leverage the throughput and security of the network.
Underneath the blockchain network layer, we get to the protocols that govern most DeFi products. Protocols include projects such as Aave, DyDx, or bZx -- each facilitates a different suite of products. One of the most interesting developments in DeFi has been the emergence and growth of the Yearn Finance (YFI) protocol. The YFI protocol, like the Compound protocol, facilitates products on the protocol through a series of smart contracts into which users can deposit specific tokens. These protocols are (mostly) maintained by developers who have a vested interest in the projects and/or receive compensation for their work through decentralised governance processes. We will cover the governance of these open DeFi protocols later in the series.
Most recently, YFI announced a series of partnerships, collaborations and mergers with other DeFi protocols and products. The growth of the ecosystem surrounding the YFI protocol is one of the first and most significant developments of decentralised teams working together, joining forces, to build an ecosystem of tools, products, and assets native to DeFi. ParaFi Capital’s Santiago Roel introduced the new YFI as, ‘yAlliance - the first vertically integrated DeFi powerhouse’.
DeFi products include lending, insurance, derivatives, prediction markets, and more. Product is an interesting descriptor for DeFi initiatives because we typically think of a product as a stand alone offering by a single entity. And, within centralised finance, products with the highest yield or greater technical attributes are typically only available to other financial institutions, not the retail market. In DeFi, that is simply not the case: products are stacked like lego blocks, and are intertwined with each other, leveraging this incredible network of open, innovative tools.
DeFi begins with an on-ramp, just like the rest of the financial world. But once you get under the hood, everything is quite different. While the technical barriers remain high for retail users, that is changing. Coding requirements are falling for certain products. User interfaces and experiences are getting better -- especially in wallets such as the Coinbase Wallet or Argent’s mobile wallet and through new updates to the popular MetaMask wallet
This thriving ecosystem has much to learn and many mountains to climb. Next up in the series we will touch on how DeFi is approaching governance, risk, and consumer protection.