Hi all,
I've put together a list of some of the top DeFi projects along with a brief explanation of each:
Maker DAO - Lending/Borrowing
MakerDAO is a decentralized system for collateralized loans that people can lock up their ETH in to receive the DAOs stablecoin, DAI. When someone locks up ETH, they are able to take out a loan of a smaller amount in DAI, which is pegged to the US dollar. A deposit of $1000 ETH would allow the user to take out a loan of roughly $650. When the person wants to get their ETH back, they simply pay back their loan along with any fees. The native token of this protocol, MKR is used in a twofold manner. It primarily acts as a form of support for the loan system as the price of ETH drops. When too many loans are liquidated at once, MKR is created and sold to pay off the loans, as well as bought back from proceeds from liquidation fees. It also serves an additional role as a governance token allowing holders to vote on how high fees should be and which types of collateral should be accepted by the system’s smart contracts. Maker has become one of the flagship protocols in the DeFi boom but as we saw with markets crash caused by Coronavirus, there remains significant risk investing/pooling money in these protocols which can suddenly become destabilized due to unpredictable events. Though Covid isn’t the first existential crisis Maker has faced, having dealt with hacks in the past, the community has continued to persist and has shown impressive resilience to move past these troubles, often coming out stronger and with a more guided roadmap. It is the largest DeFi protocol by locked value at $6.57 billion.
Aave - Lending/Borrowing
Aave is a decentralized network of collateralized lending pools run by smart contracts that allow people to freely lend or borrow crypto. In December 2020, they rolled out version 2 of their protocol. Previously when holders provided crypto for collateral on loans, it was locked in to that collateral. The new update allows users to easily transfer their collateral from one coin to another without having to repay their loan or pull it out of Aave. This increases people’s ability to manage liquidation risk by being able to swap their collateral if the original asset began falling in price. The governance token, AAVE, is used by holders to determine various changes to the rules and policies of the protocol. Holding the token also provides the user various bonuses such as reduced fees/rates, higher borrowing limits, and advance access to certain pools. Aave has also innovated “flash loans”, uncollateralized short term loans that are issued and settled within the same block of transactions. Aave’s version 2 is far from the end for this project. CEO Stani Kulechov has mentioned that upcoming changes will improve and add additional nuance to both governance and its flash loans, while also working to reduce gas fees across the board.
Yearn Finance - Asset Management
Yearn Finance is a DeFi protocol that gives users yTokens in exchange for crypto deposits that are then lent out via various other services such as Aave or Compound for the highest rate of return. Yearn.finance was created by Andre Cronje who promptly gave up the protocol and transferred governance to a smart contract that requires a supermajority to institute changes. There is a fixed supply of 30,000 YFI tokens. Yearn.finance automatically reallocates investors’ funds and finds them the highest yield across various DeFi products. In other words, it gives the average crypto investor access to more advanced strategies through a user friendly user interface. It’s name recognition and ease of use will ensure that as the space continues to grow, it will remain as many investors’ first introductions to field farming strategies. Though in itself not high risk, Yearn searches a number of high yield bearing products that can oftentimes lead to investors’ funds being put into instruments they may not personally be comfortable with. Though these may not be entirely “unsafe”, It’s fair to ask whether many of the new investors being introduced to DeFi via Yearn would feel comfortable if they knew some of the riskier strategies their funds were subject to. Additionally, the nature of crypto’s rapidly changing market conditions can lead to volatile price swings across the market and the value of yield farming assets are always at risk of becoming worthless.
Uniswap - Decentralized Exchange
Uniswap is the most popular and most used decentralized exchange (dex) built on Ethereum. It made headlines last summer when it surprised early users by airdropping 400 UNI tokens (roughly $1,200 at the time) to anyone who had used the platform. The UNI token is used to govern the Uniswap exchange and holders can vote on various proposals and will eventually be the sole decision makers of Uniswap. People can use Uniswap to trade any token built on Ethereum and can also provide Eth and other tokens to supply liquidity, earning fees and sometimes other rewards. At one point Uniswap held 20% of all funds locked in DeFi protocols and had nearly 50,000 daily users and it still remains hugely popular. Due to the surprise airdrop, the token is widely distributed among the crypto community. It’s also one of the most popular platforms users are introduced to deeper DeFi concepts such as liquidity pools and yield farming. Many Uniswap users not only use the exchange for swapping their tokens, but also to earn rewards by providing liquidity. Many of these rewards provide outstanding returns which is incredibly enticing. However there’s an underlying risk to it that many people don’t understand well. It’s called Impermanent (or Divergence) Loss and it occurs when the price of the pooled token moves far from the price the user initially provided it for.When the Automated Market Maker sells tokens to maintain the desired ratio, the underlying amounts provided are sightly affected. This risk is often offset by the fees and rewards earned, but could present a significant risk in a volatile market.
Synthetix - Derivatives
Synthetix allows holders to stake their SNX tokens to create on-chain synthetic versions of real world assets such as gold, foreign currencies, and recently oil. It also allows holders to create shorting products such as iBTC or iETH. Synthetix was founded by Kain Warwick, having raised nearly $4 million in private funding from Framework Ventures. Governance was originally handled by a foundation which has since been dissolved and replaced by three decentralized autonomous organizations (DAOs) that SNX holders can vote on decisions for the future of the protocol. Synthetix had over $800 million in total locked value at its height and continues to hold above $700 million staked with over $125 million in circulating synthetic assets. Their success shows the strong demand for the ability to trade censorship free real world assets on-chain and they continue to research, develop, and release new products. Their inverse products (iEth, iBTC, iOIL etc..) are a unique way to introduce shorting strategies to DeFi newcomers as each iSynth token has an entry point, an upper limit, and a lower limit at which point the price is frozen and the inverse asset’s holder is liquidated into a USD pegged stablecoin to help manage risk. Sythentix’s strategy of bridging traditional legacy assets and new digital assets through these innovative products presents a strong case for SNX as the space develops and matures. One of the downsides to Synthetix is its unusually high collateralization ratio, requiring 750% of staked SNX to the value of the Synth asset. Additionally SNX is more volatile than other assets such as ETH which can lead to higher risk when it comes to keeping your ratio intact. Though staking ETH is available, it offers none of the reward incentives that SNX does.
Compound - Lending/Borrowing
Compound is a decentralized crypto lending and borrowing protocol run by algorithms and smart contracts. Anyone with an internet connection and a crypto wallet such as MetaMask can supply their crypto or borrow assets at interest rates set by real time supply and demand. This allows people to lend and borrow without having to negotiate terms through a middle man such as a bank. When people deposit their crypto funds into Compound, they are provided c-tokens (cETH, cDAI etc) which represent a claim to their portion of the asset pool. Similar to other DeFi protocols, loans are overcollateralized. That is, you must provide more value in crypto as collateral than you can borrow a loan for. Compound was initially started as a company by Robert Leshner and funded by VC, but since the release of the COMP token has been gradually decentralized handing control and governance to the community. Votes have been held to add coins, adjust interest rates, and various other improvement proposals. One of the inherent risks in Compound’s model is the risk taken on by borrowers who use the funds to buy more of their collateral. If an investor deposits ETH, then uses their loan to buy more ETH, a sharp drop in the price could lead to not only a call on their loan, but also complete liquidation of their collateralized ETH. Overall, Compound is fairly simple to use and understand which will continue to allow it to be a major player in the DeFi community as more people and institutions join the space.
RenVM - Assets and Derivatives
A major problem with the current DeFi system (and really, the overall crypto space) is interoperability. That is, roughly 75% of the total crypto market cap is outside of the Ethereum blockchain and thus not able to participate and interact with the current major DeFi protocols. RenVM is trying to solve this by wrapping outside assets, acting as a decentralized version of BitGo’s WBTC. Someone who holds bitcoin can send their BTC to RenVM which acts as a decentralized custodian, and then issues them the Ethereum token renBTC which is backed, and has the same value as BTC. Not limited to just Ethereum, RenVM can provide this service for just about any digital asset and smart contracting platform. RenVM’s token, REN is used as a bond to act as a validator “darknode” on the network. It requires 100,000 REN to register and run a node which is locked into a smart contract and not returned until the person deregisters their node. This encourages good behavior from participants. Every time an asset is transferred across chains, a fee is taken which is paid out to the darknode operators.
Kyber Network - Decentralized Exchange
Kyber Network is a decentralized exchange and payments tool that allows people to instantly swap their tokens for other tokens without having to deal with a centralized order book. It makes use of pools of crypto funds called “reserves” that allow for several routes to convert the tokens, ultimately finding the best price. Though similar to Loopring, the Kyber Network has a main exchange interface and swaps the token instantly, while Loopring is the underlying protocol and network of many exchanges, and functions as an orderbook. When converting ETH into another token, the Kyber smart contract first asks various reserves to get the best exchange price. Then, you’ll see the exchange rate and decide whether or not to go through with a swap. If you proceed, you will send 1 ETH to a Kyber smart contract. Once received, the reserve will do an on-chain exchange and your account will be credited with your token of choice. When converting one ERC20 token to another, Kyber uses ETH as the intermediary. That is Token A -> ETH -> Token B. KNC is the native token of Kyber and reserve holders must pay for their right to manage the reserves with KNC. Holders can also stake their KNC to the KyberDAO which gives them governance rights as well as returning a staking reward. Additionally, it allows vendors who accept cryptocurrency to accept a wide variety, but still get paid in their preferred currency. The Kyber Network works as a service in these types of transactions.
Loopring - Decentralized Exchange and Layer 2
Loopring, though similar to Kyber, is unique in this list as it is a decentralized exchange protocol, not a dex itself. What this means is that Loopring allows anybody to build a custodial order-book based exchange on Ethereum (or any other smart-contract platform) and Loopring then combines the pools on those into one massive pool and matches orders across these separate exchanges built using Loopring’s structure and participating in the network. Additionally, when you place your order, your coins remain yours until the order is executed. Your coins aren’t locked into the order book and you can cancel or adjust your order as you please. Those responsible for matching these orders, miners, are compensated for their work in LRC, and they are incentivized with higher rewards for finding better exchange rates. Loopring is also unique in that it is a Layer Two solution. That is, all transactions and trades take place off chain and thus the fees for trading are astronomically lower than Ethereum's during busy times, the downside being that it takes a bit of extra knowledge, and the desire to actually move your crypto there.
Balancer - Decentralized Exchange
Balancer is an automated market maker similar to Uniswap in that people can provide their crypto to liquidity pools to earn rewards, but differentiated by the concept that Balancer allows people to create their own Liquidity Pools with up to eight assets pooled instead of just two. The creator of the pool arbitrarily sets the weights of the underlying assets which are automatically rebalanced as the prices fluctuate to maintain the weight. This basically allows anyone to create their own self balancing index fund or invest in someone else’s. A downside to this is increased divergent loss as the prices of the various assets can fluctuate more broadly than is possible with just two assets provided at 1:1. It also leaves open big arbitrage opportunities as there is no oracle integration to bring in outside prices, thus the prices in the pools only change when someone makes a trade. BAL is the governance token for this protocol and as the protocol develops, BAL holders will be able to “help guide the protocol to its fullest potential.” Balancer specifically names some goals such as deploying the protocol on blockchains other than Ethereum, implementing layer two solutions, introducing fees at the protocol level to generate revenue, and more as examples of actions BAL holders can make.
There ya go, hope this is helpful!
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