Over the last few years, the cryptocurrency and blockchain world has skyrocketed in popularity and value. An astounding $256 billion has made its way into this futuristic world of digital finance. But why are people throwing money at cryptocurrency? Aren’t these digital tokens just more volatile versions of stocks?
On the surface, cryptocurrency trading is pretty straightforward thanks to centralized exchanges. Traders can swap different tokens in the hopes of making a profit, much like trading stocks. But that’s the most basic function of crypto, and it’s also where the similarities end. Behind all of these cryptocurrencies resides the incredible world of decentralized finance (DeFi).
What is DeFi?
Decentralized finance, or DeFi, is the all-encompassing term for the numerous financial projects built on the blockchain. These projects, known as decentralized applications (dApps), range from decentralized exchanges (DEXs) to borrowing and lending protocols.
While they all provide different functionality, they have one primary purpose in mind: to provide a solution that doesn’t require a bank or other central regulatory power. These projects are designed to operate on their own, without the need to be regulated or controlled. Once the developers are done, the dApp can operate independently.
One of the most popular examples is the DEX, or decentralized exchange. The DEX operates similarly to a centralized exchange like Coinbase or Binance, but without the need for a company to back it. Users can go to the DEX at any time and swap between countless different cryptocurrencies for (typically) a small fee.
But DEXs aren’t the only innovative decentralized solution. Borrowing and lending dApps, known as money markets, have become increasingly popular, and allow users to do pretty incredible things.
What Is a DeFi Money Market?
A money market is essentially a place where you can go to lend or borrow cryptocurrency. But why would you want to lend your cryptocurrency? There are several reasons, which might explain the popularity of money markets in the DeFi world.
You will earn interest on the assets you lend. Depending on the dApp you use, this interest can be the same asset or other cryptocurrencies. This acts similarly to a savings account at a bank. You deposit your cryptocurrency into the protocol, and it accrues interest over time. It’s an excellent way to passively grow your cryptocurrency portfolio.
In order to borrow cryptocurrency, you have to put up collateral. So you could deposit one type of token and borrow against it to receive a different token. Here’s why you might want to do this.
- Firstly, this provides an easy way to ‘short’ the market. Meaning if you think a token will go down, you can borrow it and then immediately sell it. Then, once the token drops in price, you can purchase it back and repay the loan — keeping the difference as profit.
- In some cases, you might not want to let go of a certain cryptocurrency, but, life demands liquidity and you’re forced to sell your tokens. Instead of selling off your asset, you could simply use it as collateral and borrow against it. That way you still own the asset, but you now have some flexibility.
Leveraging your position
In stocks, online brokerages typically provide users with access to additional funds beyond what they have deposited. This is known as a margin account, and it allows you to take larger positions that mean bigger returns and losses. DeFi Money Markets provide similar functionality.
If you want to increase your exposure to a certain token, you can lend that token to the protocol and then borrow more of it. If you’re feeling risky, you could do that multiple times by lending your borrowed tokens and borrowing more.
This can get quite risky and is an easy way to lose money if the cryptocurrency goes down in value. You can also lose money if the asset price remains stagnant because you are charged a certain amount of interest on what you borrow. So be sure to do your research and understand the risks before leveraging your cryptocurrency.
What Are the Negatives?
DeFi Money Markets provide a lot of utility and functionality to cryptocurrency. But just like anything, they have their downsides. These markets aren’t subject to typical licensing or banking oversight provided by government bodies. That means they carry significantly more risk.
Deposits aren’t guaranteed, and there is no customer service agent to help you with personal account services. With complete control of your crypto comes complete responsibility for losses and mistakes. These caveats don’t seem to be deterring investors, though, as adoption continues to increase month over month.
DeFi Money Market Examples
There’s a lot going on in the DeFi world with multiple blockchains and numerous dApps. But there are several projects that are regarded as “blue-chips.” These blue-chip dApps have been tested by time, audited, and proven to be authentic and trustworthy. They are also some of the oldest protocols in DeFi.
AAVE (Ethereum, Avalanche, Polygon)
AAVE is one of the most well-known dApps available. It’s a widely used money market that holds the most TVL (Total Value Locked) out of any protocol available. It’s currently only available on a limited number of blockchains, but it allows the borrowing and lending of a wide variety of cryptocurrencies.
Other Notable Money Markets
Geist is a relatively new money market dApp available on the Fantom network. It’s actually a fork (copy) of AAVE, with a few differences. The biggest difference is that holders of the platform’s native token, $GEIST, receive 50% of the platform fees.
BENQi is the oldest money market on the Avalanche blockchain. It offers similar utility as most other money market dApps and is pretty well established.
Taking Part in the Vast World of DeFi
Decentralized finance significantly enhances what can be done with cryptocurrency and blockchain. DeFi has brought a considerable amount of utility to the decentralized world and innovations continue to add more functionality daily.
But exploring beyond centralized exchanges can be complex and difficult. It takes time and effort to learn how the many different aspects of DeFi work together. That’s why it’s important to do your own research before investing your money into anything. Find a reliable source like Taiki Maeda on Youtube, read the documents on the different dApps, and be aware of what and who you’re interacting with.
Learning from others is a great way to expand your knowledge and learn more about the ever-growing universe of blockchain and DeFi. For more information on money markets and to get an insight on how experienced users utilize them, check out Taiki’s money market video.
Have any comments, questions, or concerns? Leave them below, or get in touch via my Twitter: @CJ_Techtonic