Beyond Bitcoin

Over the last month I have been taking a deep dive into the world of cryptocurrency. What I’ve learned is that there is far more to it than owning some Bitcoin. Here are some of the most interesting use cases I’ve found.

Decentralized Lending and Money Markets

One of the core value propositions of crypto is that you are the one that controls your funds. No banks, no intermediaries. Decentralized lending and money markets take that to the next level.

Operating entirely through open source code, these protocols allow you to borrow money or earn interest on deposits, straight from a wallet secured on your computer, without anyone’s permission, instantly. For example if you deposit $100, you can borrow up to 80% of that instantly at a low interest rate while also earning interest on your deposit.

Some of these protocols are offering higher interest rates on deposits than borrowing, the complete opposite of the current banking system. Right now I can go on many of these platforms and earn 10% interest on deposit, and borrow at near zero percent interest rates. Some will even pay you to borrow cryptocurrencies.

In contrast, if I deposit into my savings account at my bank I might earn 0.1% interest, but if I borrow money I’ll have to pay at least 5%. That borrow rate is 50 times more than the savings rate.

Now if this sounds too good to be true, that’s because it might be. Protocols that offer this are operating through inflationary mechanisms by printing their own cryptocurrencies out of thin air, intriguingly similar to a central bank. If these cryptocurrencies lose their value the game is up.

The whole thing reeks of a bubble waiting to pop. But there are still other legitimate protocols that operate reasonably, with borrow rates higher than saving rates. And these savings rates are still 10x higher than traditional banking.

Now there are still more risks. Essentially, you are trading the bureaucratic, regulatory and legal hassles of operating through a bank for technology risk. People in the industry call this smart contract risk, meaning the risk that the code fails or is hacked, causing your funds to be stolen or temporarily inaccessible.

Bottom line, similar to the internet boom of the 90’s, a bunch of computer geniuses have gotten together to do some pretty interesting things. And for me these lending and borrowing protocols are at the very top of the list.

Dive Deeper: Lending And Borrowing In DEFI Explained - Aave, Compound

Tutorial: Venus.io Tutorial on the Binance Smart Chain - The Compound Finance of Binance Smart Chain

Vaults

These vaults aren’t your typical Swiss bank vault. Instead they are like decentralized lending and borrowing protocols on steroids. 

Remember those computer geniuses I mentioned above? Yeah well they don’t just like to build things. They like to make money too.

Here’s how the vaults work. You deposit your money to an open source protocol that is designed to perform a certain strategy that optimizes for maximal returns. Because crypto is a nascent industry/asset class, these strategies boil down to arbitrage. While the simple definition of arbitrage means to take advantage of a price discrepancy, the arbitrage opportunities vaults make use of are much more complex and beyond the scope of this writing.

What you need to know is that if the lending and borrowing protocols discussed above are like decentralized banking, vaults are like decentralized hedge funds.

The strategies are open, transparent and voted on by the users. While this means these strategies may not be as profitable as what private crypto hedge funds are pursuing confidentially, it does give these platforms a high degree of trust.

Returns on vaults can range anywhere from less than 1% annually to more than 1,000%. High returns on unvetted vaults holding risky underlying assets are susceptible to what is known as a “rug pull.” Rug pulls come in two forms. First, a large holder of a high risk asset may drive the price to zero through huge amounts of selling. Second, a bad development team may steal all of the funds users allocated to the vaults. With the most trusted vaults like Yearn.Finance this does not happen, no matter how high the return offered. These vaults are well established and have security measures in place to prevent a “rug pull,” even if a rogue developer were to try to initiate one.

Dive Deeper: What are YEARN VAULTS? ETH Vault Explained | DEFI, YIELD FARMING

Decentralized Exchanges

Decentralized exchanges are just what they sound like, a place to exchange cryptocurrencies without a centralized authority. These exchanges operate through what are known as “liquidity pools” to allow people to exchange cryptocurrencies without a market maker.

This means decentralized exchanges can operate like the stock market without all the infrastructure of the stock market. No order books, no buyers, no sellers, just users exchanging one token for another.

Liquidity pools are somewhat technically complex. Rudimentarily, these pools consist of two assets. Anyone can exchange one asset for another. When a user interacts with a liquidity pool by exchanging one of the assets for another this changes the balance of the two assets in the pool, automatically repricing the two assets against each other. The people who provide their funds to the pool as liquidity earn a fee each time users exchange one asset for another.

Liquidity pools are important because they fulfill the crypto principle of delivering decentralized systems rather than centralized ones.

Dive Deeper: How do LIQUIDITY POOLS work? (Uniswap, Curve, Balancer) | DEFI Explained

Yield Farming (The Wild West of Decentralized Finance)

Yield farming is a broad term to describe users maximizing returns by participating in the different decentralized finance protocols mentioned above. 

Now as you might have figured out by now, this whole system is able to exist because developers inflate the supply of their cryptocurrency in order to reward users of their protocol. 

Tokens are constantly being created out of thin air, but amazingly most are retaining or even increasing in value.

The mass psychology behind this is fascinating and a grand experiment. Of course there is greed and the risk of the bubble popping. But more than that these protocols have learned that by rewarding users with additional supply of a crypto token they are increasing network effects.

Network effects, of course, are gold when it comes to creating enterprise value. Just look at Google and Facebook compared to their competitors.

By rewarding users with additional tokens, many decentralized finance protocols are able to realize network effects that far outpace the inflation of their token supply.

Think of this like a cheat code, where increased network effects act synergistically with the original value proposition to drive further utility.

For the best protocols, this utility is real and valuation levels are sustained. But for the worst projects, utilizing this cheat code ends in tears, a giant bubble popping (rug pull) and someone left holding the bag.

Dive Deeper: What Is YIELD FARMING? DEFI Explained

If You Want to Experiment...

99% of what I have just written about was invented on Ethereum, the second largest cryptocurrency behind Bitcoin. But Ethereum has a problem. Demand for using Ethereum is outpacing supply, which means the network is congested, which means if you want to experiment on Ethereum you will have to pay anywhere from $20-$200 per transaction, even if you want to supply only $1 to a protocol.

Obviously this ruins the concept of decentralized finance and Ethereum is working on a scaling solution called Ethereum 2.0. In the meantime if you want to experiment with decentralized finance I recommend checking out the Binance Smart Chain or Solana.

‍