TradFi & DeFi deep dive 1(c): DeFi Infrastructure
Remember when The Next Block discussed how there is a hybrid hypothesis for the future, of TradFi and DeFi, suggesting that each are on a path of convergence as they tackle similar challenges to modernize the financial services experience?
As a refresher, we made the following hypotheses::
Hypothesis #1: The future of finance is hybrid & distributed.
Hypothesis #2: The future of DeFi is multi-chain & distributed.
Hypothesis #3: The future of underlying infrastructure is multi-cloud and distributed.
Hypothesis #4: The future of finance governance is hybrid & distributed.
Here’s another refresher on the landscape that we see playing out, keying in on where we will focus in this post:
Figure 1: the future of finance shows DeFi Infrastructure components that primarily serve DeFi projects
… and the following image shows a view of the respective vendors and projects building out the DeFi Infrastructure of the future:
Figure 2: DeFi Infrastructure components include both TradFi incumbents as well as new, crypto-native DeFi market entrants
DeFi Infrastructure component 1: Digital assets
Per Gartner, a digital asset is anything that is stored digitally and is uniquely identifiable that organizations can use to realize value. In the context of DeFi, digital assets in this space primarily are assets represented by the DeFi concept of tokenization, deployed on a blockchain or TradFi ecosystem, and are most frequently manifest across three asset classes: stablecoins, platform tokens, and NFTs.
Stablecoins. Stablecoins Stablecoins, a type of cryptocurrency, are a new digital asset that is effectively a cryptocurrency with a value that is pegged to a stable asset as well as fully backed with reserve assets, such as the US dollar. Some of the most notable examples of these “digital dollars” include Circle’s digital dollar (USDC), the Gemini Dollar (GUSD), and DAI.
Stablecoins are a great mechanism for bridging traditional and modern financial platforms and markets, and they also provide a stable and reliable base value for constructs like borrowing and lending. Today, 74% of all stablecoins are issued on the Ethereum network as ERC-20 tokens and nearly $1.6 trillion in USD in stablecoins and ETH was transacted on Ethereum in 2020, according to Consensys.
There are an incredible amount of benefits to stablecoins, including not having to fully exit the crypto markets when trading in and out of other assets, strong integration between traditional and modern financial environments, and a digital asset that is increasingly able to traverse both environment types as well. Read more about how Circle is accomplishing this with the USDC and is even pursuing to become a national digital currency bank. Additionally, while payments integration with traditional and modern is a great step forward, the traditional payments space is desperately in need of modernization. For example, over 65% of non-cash payments are used via ACH, which is a technology invented in the 1970s and can take multiple days to clear a transaction.
Read more here on Gemini around the various types of stablecoins and their varying collateral structures, including fiat-backed, crypto-backed, commodity-backed, or algorithmic.
For TradFi equivalents and alternatives to DeFi assets, e.g. CBDCs, check out our post here on section 1(a) of the Future of Finance detailing out TradFi Infrastructure.
Platform tokens. Specific platform tokens are generally meant for incentivizing the use of a particular platform, e.g. ETH for Ethereum.
NFTs. NFTs carry many use cases… and not just images for purchase on marketplaces like OpenSea! There are many DeFi use cases that are developing now for NFTs. One great use case of NFTs includes fractionalization of assets (e.g. mortgage securitization, bond issuance) are additional use cases that may take rise one day as well on blockchain environments like Provenance Blockchain.
There are other digital asset types to include security tokens, governance tokens, and more. Read more here from MakerDAO on their view of the various types of tokens.
DeFi Infrastructure component 2: Mining, staking, and liquidity
Mining. Powering all of these digital currencies include core cryptocurrency technology and mining infrastructure, such as Blockstream and Infura. Blockchain mining is simply the core infrastructure served up to conduct the intense computational effort provided by nodes in a blockchain network with the intent of earning new tokens as a reward for the mining effort. Mining is a key component in ensuring and verifying the legitimacy of transactions being added to additional blocks on any relevant blockchain.
Staking. Many blockchains are shifting towards, or being built from the ground up, in a manner that favors Proof of Stake (PoS) over Proof of Work (PoW), which is generally considered as more energy efficient and enables greater revenue generating capabilities for a broader user base. The best example of this is the Ethereum PoS consensus mechanism that is soon to come fully online in 2022. The decentralized infrastructure required to power these environments include concepts like Ethereum staking nodes. Validators host these nodes by committing their own collateral (32 ETH minimum), and in return for validating transactions on the blockchain they are rewarded with interest.
Liquidity. Liquidity can operate very differently in DeFi than the TradFi world to provide the available funds and assets in order to facilitate lending, borrowing, and token swapping or trading.
In DeFi, a Centralized Exchange (CEX), liquidity may resemble a bit more like what a TradFi centralized exchange may look like for conventional financial instruments. Many of these CEX’s also serve as liquidity providers for institutional investors and TradFi’s looking to partner and have backing services to offer crypto services to their clients (e.g. Paxos).
In a Decetralized Exchange (DEX) and with true DeFi projects (e.g. Aave), liquidity pools are simply locked digital assets that have been supplied by the users of the platform, in exchange for a return. A great example is Aave, an open source liquidity protocol to earn interest and lend or borrow assets. You as an individual can be your own liquidity provider!
Read more from Decrypt here on how liquidity works in DeFi.
DeFi Infrastructure component 3: Distributed ledger technology (DLT) and blockchain
The foundation and basis of all of these infrastructure, platform and application components, resides a number of blockchain use cases that span a variety of different instantiations, often most associated with Bitcoin and Ethereum as the most widely adopted blockchains for DeFi. If you are starting from square one and need to better understand blockchain and distributed ledger technology (DLT), start with the basics on Blockchain and Ethereum at Consensys.
For more on the Bitcoin Whitepaper: the original whitepaper discussing a Peer-to-Peer Electronic Cash System, which brought about Bitcoin. Read here.
For more on the Ethereum Whitepaper: the original whitepaper discussing a Next-Generation Smart Contract and Decentralized Application Platform. Read here. You can go even further down the rabbit hole with the Ethereum Organization, Ethereum Learning and Ethereum Wiki.
Also, understand the blockchain managed offerings that are springing up across technology firms and open source communities to include Consensys Quorom.
