DISCLAIMER: Please be advised that this article is not intended as investment, tax, financial or legal advice. Interested readers should seek out professional advice for their particular situation.
Decentralized Finance (DeFi) is a rapidly growing sector of the cryptocurrency space and shows a lot of promise when it comes to the future of finance. DeFi is well on its way to revolutionizing the world of financial services, and that includes loans. While the landscape is relatively new, it is growing quickly.
In this article we examine what DeFi is, what DeFi tokens are, and some of the most popular DeFi tokens that are available.
In very simple terms, Decentralized Finance or DeFi is an ecosystem of different financial applications that are built on blockchain networks. The Ethereum blockchain has been the most popular to build on so far because of its smart contract capabilities, which we’ll discuss in more detail later.
The main purpose of DeFi is to create an open-source and transparent financial service ecosystem. In theory and in practice, DeFi is available to everyone and operates without any type of central authority. Current DeFi products and services include banking services, decentralized marketplaces, custodial services, investment services, decentralized exchanges, borrowing and lending, and more.
The majority of DeFi applications make use of smart contracts. While a normal contract makes use of legal terminology to specify the details of the relationship between entities entering a contract, a smart contract makes use of computer code. Because the terms are written in computer code, smart contracts also have the ability to enforce the contract terms through computer code. This allows for the automation and reliable execution of many business processes that would normally require manual supervision.
The main benefit of DeFi is accessibility. There are over 1.7 billion adults currently unbanked (meaning they have no bank account), and DeFi has the possibility to change that as it offers easy access to financial services. Additionally, users maintain full control over their assets.
Another advantage of DeFi is that the framework is interoperable. This can then lead to the creation of new financial markets, services, and products. DeFi applications (or dapps) are also relatively inexpensive to run. They don’t need any intermediaries or arbitrators as all possible disputes and resolutions are specified in the code.
Much like other blockchain projects, some Decentralized Finance platforms (such as lending platforms and exchanges) have their own token. These can not only have financial value, but can also contribute to how these platforms function on a larger scale. There has been a constant evolution in token distribution frameworks, with the most recent iteration Simple Agreement for Future Governance (SAFG) being introduced in May 2020.
When it comes to SAFG, it’s a simple token distribution mechanism where participation in a specific action earns a predetermined amount of tokens, which then grants users the ability to vote on future changes. In this case, tokens are typically non-transferable and they do not possess any economic value.
Typically, on DeFi platforms that offer exchange and lending services, tokens have a financial value. Users may be incentivized to use a platform’s native token by being offered a lower interest rate, or receive free tokens for specific actions.
With hundreds of DeFi platforms on the market, there are a lot of DeFi tokens out there as well. Here we outline some of the most popular DeFi tokens on the market.
Compound is a decentralized crypto lending platform that allows users to earn COMP by lending or borrowing assets. The interest rates paid and received by borrowers and lenders are determined by the supply and demand of each crypto asset. The amount of COMP allocated to markets is relative to the amount of interest earned, so assets that generate more interest will earn more COMP per day.
Additionally, COMP is used to govern important protocol decisions. These can then be voted on or delegated to another user on the Compound Governance Dashboard.
MakerDAO is a popular DeFi platform that offers a lot of different services to its users under different names. They offer decentralized lending services through their sub-company Oasis and also have their own cryptocurrency, Dai, which is soft-pegged to the USD.
The platform also has their own DeFi token - MKR. Anyone can be an MKR holder if they wish to be. Essentially, MKR holders are responsible for governing the Maker Protocol. This includes adjusting policies regarding the Dai stablecoin, choosing new collateral types, and improving governance of the platform itself.
Kyber Network is a blockchain-based liquidity protocol that collects liquidity from a wide range of reserves, powering instant and secure token exchange in any decentralized application. The platform has its own governing system, KyberDAO, which makes use of their DeFi token KNC.
KyberDAO allows KNC token holders to participate in platform governance. KNC holders can stake their KNC to vote on proposals for the future of the platform. In exchange, holders receive rewards in ETH from network fees, which are collected from trading activities on the Kyber Network.
0x is a permissionless liquidity protocol used for connecting liquidity providers, creating decentralized exchanges, and incentivizing the market to fuel DeFi asset trading. The platform is built on Ethereum and is not a decentralized exchange itself. Rather, 0x offers the infrastructure for building decentralized exchanges.
The platform’s native token, ZRX, serves a couple of different uses. Firstly, users can stake their ZRX with 0x market makers to earn rewards. Additionally, ZRX is also used for governance purposes. ZRX holders can vote on 0x improvement protocols using their tokens.
Bancor is a decentralized exchange which is powered by their native token - BNT. The way this works is that a portion of trading fees, collected from the exchange, are distributed to BNT holders. While Bancor has yet to introduce governance as part of BNT, it is strongly believed that this will be coming soon on the platform.
UMA is a decentralized protocol that creates globally accessible financial markets on Ethereum. By using concepts borrowed from fiat financial derivatives, UMA defines an open-source protocol that allows any two counterparties to design and create their own financial contracts. However, unlike traditional derivatives, UMA contracts are secured with economic incentives alone, which makes them accessible and self-enforcing.
The platform’s native DeFi token, UMA, is used to govern protocol decisions. Additionally, UMA can be used to challenge underlying registries that are out of sync with the synthetic asset they are attached to.
Numerai is an AI-based hedge fund responsible for the creation of Erasure. Erasure is a decentralized marketplace for stock-trading data, built on Ethereum and IPFS. The marketplace is unique in that it allows anybody to make market predictions, stake on them using its native NMR token, and build a verifiable track record.
Balancer is an asset management platform that acts as a liquidity provider, an automated portfolio manager, and a price sensor. The platform recently launched a native token for governance purposes - BAL. BAL is used to vote on protocol upgrades that include fees, supported collateral, and incentives. The DeFi token can be earned through the Liquidity Mining program, which gives users BAL in exchange for providing liquidity to Balancer Pools.
Aave is a DeFi lending platform that allows users to lend and borrow a diverse range of cryptocurrencies using both stable and variable interest rates. The platform is unique compared to other crypto lending platforms in that it has features such as uncollateralized loans, flash loans, and unique collateral types.
Aave has a native token, LEND, which currently provides holders with discounted fees. In the near future, LEND will also be staked for governance and as a first line of defense for outstanding loans.
As you can see, the DeFi token landscape is vast and varied. Some platforms use their DeFi token for governance purposes, others use it for economic purposes, and some even do both. The industry is incredibly innovative and is constantly evolving to offer more and more unique solutions to the world.
This year, DeFi tokens have seen a huge rise in popularity. Tokens for popular apps in the DeFi space have been showing large gains both long term and short term. In fact, in June 2020 the DeFi sector was significantly outperforming Bitcoin. As such, the future of DeFi looks very promising.
While the DeFi space is still playing catch up with the current financial industry, it is making massive strides and it is exciting to watch this space unfold. The potential innovations that can come out of DeFi have the possibility to revolutionize that financial industry as we know it.