Liquidity pools are the foundation of the DeFi ecosystem. Moreover, it tries to resolve some specific issues that have been bugging the crypto community for a long time.
DeFi: A Viable Investment?
Prospects and benefits of DeFi as a viable investment, when compared to traditional investments.
The introduction of cryptocurrency was a welcome change for investors around the world; it had been decades since a new asset class was introduced into the market. The excitement generated by this novel, advanced new asset class may very well have been one of the main factors in triggering growth and acceptance of cryptocurrency as an investment.
The crypto industry has since presented several investment opportunities during the last few years, and the latest addition to this list is DeFi.
DeFi is short for Decentralized Finance. In simple terms, DeFi is an ecosystem of financial services that are built on top of blockchain networks.
Most developments in the DeFi space happen on the Ethereum blockchain. Nevertheless, numerous other projects have also garnered recognition in this space.
Like any new investment opportunity in its early days, DeFi has also had to deal with a lot of skepticism.
In this article, we’ll be analyzing DeFi’s viability as an investment when compared to other traditional investment opportunities.
DeFi: An Overview
Similar to traditional investments, DeFi is also governed by a contract, or to be precise, a smart contract. A smart contract makes use of computer code, which ensures automatic enforcement of the contract terms.
As mentioned earlier, DeFi is a financial ecosystem, and many of the companies offering services in this ecosystem may resemble traditional banks. However, since DeFi is essentially decentralized, it’s an improvement to the traditional banking ecosystem as:
- All financial processes happen on top of a blockchain network by utilizing a cryptocurrency coin.
- The contracts and transactions are secure and more transparent, owing to decentralization.
- Everyone around the world, irrespective of any eligibility criteria, has access to the service.
- Paperwork and other compliance requirements are at a bare minimum.
Although these factors can significantly influence an investor when choosing an investment, the deciding factor tends to be the Return on Investment or ROI.
Before applying this deciding factor on DeFi, let’s take a look at how some traditional investments perform in this regard.
Bonds are one of the primary choices of investment around the world. According to Investopedia, a bond “is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental)”.
Even though they are one of the most widely utilized investment methods, the ROI on bonds (both Government as well as Corporate) is one of the lowest for any investment class.
In fact, as per recent data, the yields from most Government bonds across the world have either plunged to a negative yield or are about to.
Source – tradingeconomics.com
Four out of the twelve countries listed in the above table are providing a negative yield, which simply means that there is a good chance that the investor will receive an amount that is less than the initial investment.
The other eight countries do not provide much of a gain either; the highest percentage of yield among these countries is a meager 0.83%.
Corporate bonds are not much of an exception, with the yield % ranging from <1% – 4%, and with higher risk. Combine these rates with the inflation of a given fiat-currency, and most investors are almost certain to receive a negative ROI.
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For any investor, keeping their money in a bank account should be the least favorable investment method, because most current accounts carry a 0% interest or will cannibalize funds due to fees. However, there are a good number of people who continue to do this.
Another reason for traditional bank accounts being the least favorite is due to the fact that every currency around the world is subject to inflation, and some more than others. Hence, if a bank offers x% of interest on your savings account for a certain period, it is not necessarily a given that you will have a profitable investment at the end of the period.
In reality, you should subtract the average rate of inflation of the currency from x% and then calculate that over the same period to get the actual return on your investment. Although the interest percentage varies across countries, the above-mentioned criteria remain the same.
The rate of inflation effectively benefits the banks in their business but reduces or stagnates the value of your investment over time.
Moreover, some banks would also need an investor to maintain a minimum balance in their account; failure to do so often results in penalties. This effectively means that an investor would have to pay an amount to the bank for their investment. As an investor, that should be the last thing you want to have to do.
These and similar factors make investments with banks the least favorable option for most investors, both in the long and the short term.
DeFi as an Investment
Now that we’ve analyzed the possibilities of the most widely-used investment methods, let’s compare them with DeFi.
DeFi offers a variety of investment opportunities for a potential investor, through stablecoins and crypto-backed lending and savings accounts. Even further, DeFi offers a higher rate of interest when compared to any of the traditional investments.
Stablecoin lending offers interest rates ranging from 8% – 12% for an investor, against stable fiat currency. Moreover, an investor has little or no risk of volatility since a stablecoin is immune to volatility against fiat. Volatility has been one of the main factors that have discouraged traditional investors from investing in crypto.
With regards to savings accounts, there are DeFi platforms that offer savings accounts to their users, with interest rates up to 10%, depending on the day.
The chart below effectively summarizes the position of DeFi as an investment opportunity against traditional investments like bonds and banks.
Although still in its early days, DeFi has already made a place for itself in the financial industry. With the backing of one of the most innovative technologies of our time, and with a higher ROI compared to traditional investments, DeFi is quickly turning out to be a popular choice among investors.
It is no wonder that some of the unreliable returns from traditional investment methods have led many investors to include DeFi-related investments in their portfolio.
Factors like volatility-immune stablecoins with an APR that is almost double the average return of traditional stocks would make even the hardest critics of crypto happy. DeFi might still be new, but it looks like it’s here to stay.