TradFi & DeFi deep dive 2(c): DeFi Platforms
This week we continue building the map of the future of finance across both TradFi and DeFi, with section 2(c) that describes DeFi Platforms. This denotes platforms that serve primarily or exclusively DeFi assets and services, many of which are FinTechs and challenger banking models that have expanded into supporting a broader array of assets.
DeFi platforms are a key component in the hybrid hypothesis for the future of the financial services experience, of TradFi and DeFi that suggests: (1) The future of finance is hybrid & distributed; (2) the future of DeFi is multi-chain & distributed; (3) the future of underlying infrastructure is multi-cloud and distributed; and (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 the DeFi platform components that enable smart contracts, protocols and dApps
… and the following image shows a view of the respective vendors and projects building out the DeFi Platforms of the future:
Figure 2: some of the major players in DeFi platforms spanning CEXs, DEXs, crypto custody platforms and smart contracts
DeFi Platform component 1: Centralized & Decentralized Exchanges (CEX/DEX)
Centralized & Decentralized Exchanges (CEX/DEX) serve as the primary on-ramp from the TradFi world of fiat currency, and into the digital asset ecosystem where fiat can be exchanged for stablecoins, cryptocurrencies, and NFTs. CEX and DEX platforms have different nuances detailed below.
Centralized Exchanges (CEX).
CEX projects look and feel similar to conventional TradFi exchange and FinTech brokerage environments like TD Ameritrade and Robinhood. However, they provide an ability to buy, hold, and sell digital assets like stablecoins, cryptocurrencies, and NFTs rather than equities and ETFs. They also provide a direct on ramp to digital assets and most often are associated with compliant platforms, such as participating in KYC practices. Some great examples here include Coinbase, Gemini, and Binance. Note that within this framework, these are crypto native projects that technically qualify as Centralized Finance (CeFi) rather than pure play DeFi or TradFi.
Decentralized Exchanges (DEX).
A DEX is decentralized platform that allows the customer to engage in a manner where they maintain complete ownership of the assets they are intending to swap or transact with, as well as doing so in a completely anonymous manner. The way that customers are able to maintain complete ownership is typically done by connecting a non-custodial wallet, such as Coinbase Wallet or Metamask, directly with the DEX environment, such as Uniswap. Some great examples here include Uniswap and SushiSwap.
Another model is the concept of DEX aggregators, or platforms that aggregate the best price and transaction fees from a host of other pure play DEX’s. Great examples here include 1inch, ParaSwap, a DeFi aggregator.
DeFi Platform component 2: Crypto native platforms & custody.
The vast majority of TradFi institutions have relied on crypto native custodial platforms and services rather than build their own ecosystems. These platforms provide various methods of storing and protecting digital assets on behalf of their institutional TradFi and Defi owners with other value added services. Some great examples of custodial platforms include Paxos, Fireblocks, and Anchorage Digital. They are often formed as trust companies by which TradFi’s will partner with for custodial services.
These platforms have made great strides lately in catering to TradFi’s constraints and requirements to engage with digital assets, when you consider (1) the Paxos regulated digital dollar; and (2) brokerage, stablecoins and payments for TradFi, and more. Also, Fireblocks Permissioned DeFi is a great example of DeFi products and services that have the appropriate controls that institutions need in order to engage with.
Also key to note are these platforms are generally CeFi in nature. A number of centralized platform failures. Celsius (which provided institutional services), and BlockFi have had significant issues and even bankruptcy filings in the wake of the crypto market crash. These are generally crypto lenders but also offer custodial services to TradFi and DeFi.
DeFi Platform component 3: Smart contracts platforms (L1 & L2)
Layer 1. Layer 1 is the base blockchain, of which Bitcoin and Ethereum are the most widely adopted examples. Generally, Layer 1 in used in the context of Ethereum as the base blockchain for building and executing smart contracts and serving as the underlying ecosystem for Layer 2 technologies to interact with (see section below).
But what are smart contracts? Smart contracts are computer protocols that facilitate, verify, or enforce the negotiation and performance of some sort of agreement. For instance, a smart contract could be used to represent a legal contract emulating the logic of contractual clauses or a financial contract specifying responsibilities of the counterparts and automated flows of value (Consensys).
Ethereum is the largest Layer 1 solution with 5.5 million active addresses, 1.1 million daily transactions, and approximately 4 million monthly active developers.
If you already understand the basics of blockchain technology & cryptocurrency, understanding Ethereum and its basic layers is key, as well as the components that are foundational to DeFi: smart contracts, stablecoins, etc.
Ethereum as defined from Consensys: Ethereum is an open source blockchain that was officially launched in 2015. Built by developers for developers, Ethereum is often considered the most programmable blockchain for creating smart contracts and decentralized applications, also known as Dapps. In recent years, Ethereum has also emerged as the default platform for enterprise deployments. It is currently the most actively developed blockchain in the world, with the highest daily value transfer of any blockchain network (2, Consensys).
In order to best describe the Ethereum Layers, a comparative analysis with the layers of the Apple ecosystem is a great way to understand the layers of Ethereum in a very simple way:
Figure 3: Ethereum layers in the context of the Apple analogy
Read more here to better understand Ethereum in the context of the Apple analogy andDeFi, and the hybrid hypothesis of the future.
Layer 2. The rise of Layer 2 solutions have been a response to some of the shortcomings of the early days of Ethereum, namely with respect to scalability and high transaction fees. The capacity and transaction volume supported will be 100,000 transactions per second in the future, but today there are bottlenecks that must be addressed.
Layer 2 addresses current scaling shortcomings of Ethereum by processing and batching multiple transactions off of Ethereum Mainnet as the Layer 1, inheriting the security of Ethereum, then interacting with Layer 1 with a single transaction added to the blockchain of those batched transactions.
Read more here to better understand the various types of Layer 2 solutions, namely optimistic rollups and zero knowledge rollups, among other off and on-chain scaling methods. Some of the best examples here include Polygon,
Read more here at 101 Blockchains to better understand the different types of Ethereum Layer 2 solutions and some of the leading projects.
