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Case Study: Understanding the Evolution of DeFi in 2020

Basics of Cryptocurrency
Last updated September 25, 2020

DeFi, short for Decentralized Finance, has been skyrocketing in the Q3 of 2020. However, with the experience of 2017’ ICOs, there are some fears in the community that DeFis are just a bubble that is soon to burst.

Let’s take a deeper look into this matter and see what’s going on with Decentralized Finance.

What is Decentralized Finance?

What is Decentralized Finance

Decentralized Finance represents a sector of the cryptocurrency industry formed by decentralized financial instruments that are separate from the traditional centralized institutions.

The DeFis mainly work as modules that can be used in relation to other decentralized applications. As they are built on blockchain ecosystems, these modules are meant to form an open-source system that can operate without any central authority and be permissionless, transparent, and most importantly, available to everyone.

Thus, DeFi comes to facilitate access to unbiased financial services where the modular framework allows a variety of functions and operations based on code and no intermediaries.

To this point, it may sound like DeFis are just some other dapps that mention something about modules. Well, there is more than that.

SIDENOTE. A dapp (decentralized application) is an application that runs on a distributed network of computers instead of a single central computer.

First, some of the forms DeFis come in are:

  • Asset Management tools;
  • Alternative Savings Apps;
  • Decentralized exchanges;
  • DeFi Infrastructure & Dev Tooling;
  • Decentralized Insurance Platforms;
  • Analytics tools.

There are of course other forms of DeFis but we’ll get into that later. Now, it’s important to notice the various purposes they have and understand the difference between data silos and data interoperability.

While in the past developers rolled out numerous great decentralized apps, most of the time they would operate separately, thus creating data silos.

SIDENOTE. Data silos represent bulks of data that cannot operate with each other, hindering interoperability, holistic views, and efficiency.

Taking your hands as an analogy, imagine driving or riding a bike if your right hand would never coordinate with your left hand. It would be a nightmare.

However, The DeFi sector implements the modular framework in building dapps to have them work in cohesion. And this is why they are so important for the cryptocurrency world.

2017-2018 ICO Wave | 2018-2019 IEO Tide | 2019-2020 DeFi Flood

2017-2018 ICO Wave 2018-2019 IEO Tide 2019-2020 DeFi Flood

Regardless of their importance, the sudden growth of DeFi stirs up memories. Just like decentralized finance now in 2020, ICOs were the main focus in 2017.

As we can see in the chart above, in 2017 ICOs were able to raise $10 billion. And it took only 966 ICOs to do that. But the situation started to decline in the following years.

Although they raised $11.4 billion in 2018, it took 2,284 ICOs to do so. 

And because of the numerous scams, this way of raising money became less and less popular, to the point where 350 ICOs managed to raise only $0.37 billion in 2019.

However, the vacuum was filled with something else, namely IEOs.

The first IEOs took place in 2017 on Binance, and they were dedicated to Gifto and Bread, raising $0.0012 billion.

But as IEOs started to present more trust for taking place on exchange platforms, in 2018, 42 IEOs managed to raise $0.266 billion, and in 2019, 309 IEOs raised $1.89 billion.

As for Decentralized Finance, the data we found on Defipulse tells us that by the end of 2017, the total value locked in DeFi was around $0.045 billion. In 2018 it went up to $0.241, and in 2019, up to $0.67 billion.

DeFi evolution in 2020

As for 2020, DeFi’ total value locked passed $1 billion for the first time in Q1, in February. In Q2, it kept going up to $1.9 billion. As for Q3, the bull run was clear as the Total Value Locked in DeFi passed $10 billion in September.

So, by looking at data, we cannot help but see some similarities between the ICOs growth and the DeFis growth.

There is no doubt that Decentralized Finance will get trimmed down at some point and only the best projects will stay on the market. Yet, it’s important to understand that the incentivizing system and the way of raising liquidity between an ICO and DeFi differ.

Yield Farming, Liquidity Mining, and Staking

The bread and the butter of DeFi comes from Yield Farming, Liquidity Mining, and Staking – in other words, the rewards system.

Yield farming is also called liquidity mining. Yet, although it’s not wrong, there is a slight difference. Yield farming represents a method of generating rewards from locking up cryptocurrencies. The term yield has approximately the same meaning as it does in the bond market. As you lock in your funds and grant liquidity to a DeFi token, you will get rewards and interest.

The little technical difference that liquidity mining comes with is that it implies that as you provide liquidity, you will also get additional tokens to your reward.

Aside from technicalities, the users that grant liquidity are usually called liquidity providers and they manage to do that by locking their money in a liquidity pool, which is essentially a smart contract.

As for staking in DeFi, some projects will also call liquidity mining staking. On a semantic level, they are not wrong, as the funds you lock-in can be indeed interpreted literally as a stake, but not all of them have a proof-of-stake component.

However, some projects do include a proof-of-stake layer that allows you to open up a node or delegate to a node.

The Main Types of DeFi Projects

DeFi Ecosystems

According to the data from Defiprime, there appear to be 251 DeFis that are divided into 3 main ecosystems:

  • Ethereum 81.6% (205)
  • Bitcoin 9.6% (24)
  • EOS 8.8% (22)

There is no surprise that developers chose the Ethereum platform as its smart contracts are the most popular for building dapps for allowing interoperability.

The high preference for the Ethereum ecosystem can also be seen in the increase in the price of Ether.

Aside from the ecosystem, DeFis are also divided by purpose.

Defi Project types

1. Decentralized Exchanges (15.8%)

A decentralized exchange (DEX) is a cryptocurrency exchange which operates in a decentralized way – without a central authority.

2. DeFi Infrastructure & Dev Tools (15.4%)

DeFi Infrastructure and Dev Tools refer to protocols, frameworks, and technologies for building decentralized finance dapps with DeFi modular frameworks.

3. Asset Management tools (12.3%)

Asset Management tools refer to DeFi operable wallets, apps, and dashboards for managing your cryptocurrencies and assets. 

4. Analytics (11%)

Analytics tools refer to the modules that facilitate the analysis, discovery, interpretation, and communication in DeFi protocols data.

5. Staking (5.7%)

Staking can be similar to a savings account in a bank. In Defi, service providers replace the bank, acting as staking pools and staking-as-a-service providers to run nodes for decentralized PoS protocols on behalf of investors.

6. Stablecoins (5.7%)

Stablecoins are low volatility cryptocurrencies created by pegging a more or less stable asset.

7. Payments Solutions and Service Providers (4.8%)

DeFi payments refer to the apps, protocols and solutions focused on creating an open finance ecosystem.

8. KYC & Identity (4.8%)

Know Your Customer and Identity solutions are blockchain framework solutions that offer shared regulatory compliance and user data management.

9. Asset Tokenization (4.8%)

Asset Tokenization platforms are tools that facilitate the creation of tokens, the issuing of real equity on security tokens, digitize securities, and serve as end-to-end solutions for raising capital.

10. Derivatives (3.5%)

Derivatives represent contracts that derive their value from the performance of an underlying asset.

11. Marketplaces (3.1%)

DeFi Marketplaces refer to decentralized e-commerce sites where multiple third parties can provide products or services such as crypto-collectibles, limited-edition goods, or freelance gigs. 

12. Decentralized Lending & Borrowing (3.1%)

Decentralized Lending & Borrowing platforms provide loans to businesses or regular users without intermediaries.

13. DAO Platforms (3.1%)

Decentralized Autonomous Organization platforms have the role to enforce digital rules directly controlled by shareholders without hierarchical management.

14. Prediction Markets (1.8%)

Prediction Markets are exchange-traded markets created to trade the outcome of events. (Basically, a way to earn money for being right.)

15. Decentralized Insurance Platforms (1.8%)

The DeFi Insurance platforms are tools to cover potential risks within a smart contract.

16. Margin Trading (1.8%)

DeFi margin trading refers to using borrowed funds from a broker to trade crypto assets, which forms the collateral for the loan.

17. Alternative Savings Apps (1.8%)

DeFi Alternative Savings Apps are introducing DeFi savings products to non-crypto native users and act as an alternative interface for lending protocols.

5 Best Performing DeFi Tokens

5 Best Performing DeFi Tokens

Now that we know what are the types of Decentralized Finance projects and what they do, let’s take another step forward and see what are the best performing DeFi tokens by market cap.

1. LINK (Chainlink)

LINK is the #1 DeFi token by market cap. Although it was quite controversial at the moment when CoinMarketCap added it as a DeFi token, the crypto community seemed to have accepted it as it is.

Link is the token of the Chainlink decentralized oracle network. Chainlink has been long known for its blockchain interoperability capabilities, and in the DeFi sector it contributes as an infrastructure & Dev Tool solution that provides external data to smart contracts.

(At the time of this writing LINK’s market cap is $3,608,993,249 and the price is $10.38).

2. WBTC (Wrapped Bitcoin)

The #2 top-performing DeFi token is Wrapped Bitcoin, which enables Bitcoin holders to convert their BTC into the WBTC ERC20 token in order to interact with and access dapps on the Ethereum ecosystem. In the DeFi sector, WBTC is regarded as a stablecoin.

(At the time of this writing WBTC’s market cap is $904,917,615 and the price is $10,660.77).

3. DAI (Dai)

Dai is another DeFi stablecoin, and the #3 DeFi token by market cap. Unlike WBTC, the DAI is soft-pegged to USD. Although built on Ethereum, it is governed by the MakerDAO protocol, which allows anyone anywhere in the world to generate Dai.

As a DeFi Stablecoin, DAI integrates with numerous DeFi projects such as CHAI.money derivate, Liquality and Oasi decentralized exchanges, Oasis Borrow decentralized lending & borrowing solution, and many more.

(At the time of this writing DAI’s market cap is $899,722,166 and the price is $1.01).

4. YFI (Yearn.Finance)

YFI is the #4 DeFi token by market cap. It is the native token of Yearn.Finance, a decentralized finance platform that aggregates liquidity, leverages trading, and automates yield-maximizing profit switching opportunities for liquidity providers and yield farmers.

(At the time of this writing YFI’s market cap is $729,692,173 and the price is $24,349.38).

5. LEND (Aave)

Lend is the #5 DeFi token by market cap. It is the ERC20 token of AAVE decentralized lending & borrowing platform that allows users to earn interest on deposits and borrow assets.

(At the time of this writing LEND’s market cap is $656,856,143 and the price is $0.505274).

Final thoughts

  • Decentralized Finance represents a sector of the cryptocurrency industry formed by decentralized financial instruments that are separate from the traditional centralized institutions. DeFis mainly work as modules that can be used in relation with other decentralized applications.
  • The 2020 DeFi bull run tends to resemble the ICOs explosion of 2017-2018, by signing above $10 billion in a short period of time.
  • The bread and the butter of DeFi come from Yield Farming, Liquidity Mining, and Staking because they bring liquidity inside this cryptocurrency sector.
  • DeFis can be divided by the ecosystem they are built on (Ethereum, Bitcoin, EOS) or by their purpose (DeFi Infrastructure & Dev Tooling, Decentralized exchanges, Asset Management tools, Staking, Analytics, and more).
  • The Best Performing DeFi tokens by market cap are LINK, WBTC, DAI, YFI, and LEND.
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