Few subjects fascinate as much as decentralised finance (DeFi). Since the first projects appeared in 2017, the debate has been ongoing.
For its supporters, it's a playground for innovation and the creation of a more inclusive financial system. 🙌
For its detractors, it's more a symptom of an ultra-financial, speculation-driven ecosystem. 🤑
What is the reality? As is the case almost every time, things are a little more nuanced.
To grasp what DeFi brings, we first need to understand what we're talking about.
DeFi is an alternative financial infrastructure based on the characteristics of blockchain protocols, i.e. decentralisation and transparency.
In its "purest" form, it allows financial services to be operated without going through a central authority, usually a bank. With DeFi, you can get a loan or invest your savings without going through Deutsche Bank or BNP Paribas. 🏦
The best-known DeFi applications are Maker (decentralised stablecoin) , Aave (loans without intermediaries) and Uniswap (digital asset exchange without intermediaries). But how many people are actually using them?
"DeFi is still in its infancy. Whether it's the number of applications or the number of users, the figures are very low," explains Stanislas Barthélémi, crypto expert for KPMG. Only 400,000 to 600,000 people use them on average each month (chart below). "It's clearly a niche within the crypto ecosystem", he continues.
Unique monthly users of DeFi protocols. Source : Dune Analytics
Currently, DeFi is mainly used by traders to borrow more liquidity without going through centralised exchange platforms (Binance, Coinbase, etc.). 📈
Taken from this angle, we're a long way from a system that would correct the shortcomings of traditional finance, particularly in terms of accessibility and impact on the real economy.
It's a fact: no one borrows stablecoins by placing cryptos as collateral in Aave to finance a property purchase or entrepreneurial project. Why not? Mainly because you have to place as much (if not more) capital as collateral as the sum borrowed.
"We certainly have to mourn the passing of this type of DeFi use, at least in the short term," bellows one expert. "To offer a truly inclusive borrowing system, we would have to develop sub-collateralised loans that would be repaid via small monthly instalments, but players would have to bear the risk of the borrower defaulting," he continues.
This implies that traditional credit specialists would have to be involved in this infrastructure (insurers in particular), which is not very compatible with Web3 philosophy. And even if the players in the sector wanted to, the expertise is still far from being there...
"We're still in the very early days of decentralised finance, so it's not surprising to encounter these kinds of obstacles", stresses Stanislas Barthélémi. "However, we shouldn't lose sight of the fact that DeFi offers financial tools that the average person would never have had access to in the traditional world," he adds. 👍
The example of Uniswap is interesting in this respect: the application allows any token to be listed on the platform so that it can be exchanged for other securities without an intermediary. In the traditional world, 'listing' on the stock market can be much more complicated. Above all, being listed on one financial centre does not mean you can be listed everywhere.
Uniswap (and more generally DEX aggregators such as Paraswap) is a very important milestone in the ecosystem that is being put in place.
Among the other major projects, we can also mention Lido , which tokenises the deposits that secure Ethereum ($9 billion in immobilised value) and Curve ($5 billion) positioned on the exchange of assets of the same value.
The largest DeFi projects ranked by fixed asset value (TVL). Source : DeFiLlama
As for less mature applications, but with interesting potential, we can mention GMX ($600 million) or dYdX ($370 million), decentralised exchange platforms with an order book (designed on Arbitrum for GMX, Starkware and soon Cosmos for dYdX).
All these projects enable financial transactions to be carried out without entrusting the funds to third parties (non-custodial). "Where DeFi is already a great success is in the fact that it dispenses with intermediaries," points out Stanislas Barthélémi.
Now, it needs to become more efficient to justify its status as an alternative infrastructure.
From the "crypto-casino" to the real economy
And the task looks set to be quite considerable. "There are still a lot of flaws in DeFi in terms of risk, efficiency and accessibility, especially for institutional players," argues Paul Frambot, co-founder of Morpho, a protocol that optimises deposit and borrowing rates on Aave and Compound. "If we're honest, DeFi is still a kind of crypto-casino with no rules," he points out.
For the French entrepreneur, however, DeFi is full of promise and perhaps connected to the real economy. "That's what we're working on", he explains.
Paul Frambot mentions in particular the possibility of "plugging into" the "repo" (Sale and Repurchase Agreements) market, i.e. refinancing, to which only a few institutional financial players currently have access.
The repo rate is the rate at which central banks lend to commercial banks. If end savers cannot benefit from the same conditions, it is mainly because of the number of financial intermediaries who each take the equivalent of a small commission. 💰
"By eliminating these intermediaries, we could greatly optimise the efficiency of the system for the benefit of individuals at the end of the chain", believes Paul Frambot. "Traditional finance works poorly for operational reasons, DeFi is a response that can improve the existing infrastructure."
A relevant use case: corporate finance
The interweaving of DeFi with traditional finance seems to be one way forward for most experts, mainly through the use of decentralised stablecoins, such as the DAI dollar (issued by Maker) or the agEUR (issued by Angle).
Currently, any organisation can issue a stablecoin if it holds sufficient currencies (euros, dollars, etc.) to guarantee the stability of its token. One example is Circle with its USDC stablecoin backed by dollars.
But this could go beyond currencies: the same logic could apply to securities (shares, bonds, ETFs, etc.) with interesting consequences for companies and their financing.
"It is very difficult today for many companies to use certain securities (such as commercial papers ) as collateral against cash," says Pablo Veyrat , co-founder of the Angle protocol.
"It would be entirely conceivable to place these securities in Angle in exchange for issuing euro stablecoins. Using your long-term assets to finance your short-term activity, that's a very concrete use case for DeFi," assures the entrepreneur. 🤝
According to him, the tokenisation of financial securities is not yet widespread because of the difficulty of setting up such solutions and also their cost. For example, you have to pay blockchain oracles to monitor the prices of tokenised assets. "On top of that, you have to have liquidators capable of repaying the debt and recovering the tokenised products if their value falls", he continues.
In short, what's missing is a whole specialised ecosystem that doesn't yet exist... But things are moving, and Ondo Finance is one of the players making things happen. The American company issues tokens backed by ETFs representing US Treasury bonds managed by asset management giant BlackRock.
Swiss firm Backed Finance, meanwhile, provides access to tokenised index funds also held by BlackRock. By acquiring Backed Finance's bCSPX tokens, investors can gain exposure to the iShares Core S&P 500 UCITS, the ETF that tracks the performance of the 500 largest US companies listed on Wall Street's flagship index.
The future of traditional finance?
For Adam Levi, co-founder of Backed Finance, DeFi makes it easier to access investments 24 hours a day (whereas the traditional market is only open for a few hours on working days) and whose settlements are executed in complete transparency in less than five minutes. ⏱
Fees are also much lower than using brokers who take their commission.
Adam Levi is not alone in this view. BlackRock boss Larry Fink said in early December that the next revolution for the markets will be driven by the tokenisation of financial securities, also touting "instant settlement" and "lower fees".
"It's pretty incredible what Backed has managed to do," Pablo Veyrat points out, "I hope the project holds up legally because there are still a lot of regulatory uncertainties..." 😓
Backed assures that it is compliant with the Swiss "DLT" law of 2021. This now recognises digital assets in the same way as traditional financial assets, allowing them to be tokenised. This law is one of the first in the world to clarify this aspect. Is this enough for the development of products like Backed?
"This product is legal in Switzerland... but only there for the time being," moderates William O'Rorke, a partner in the French law firm ORWL, which specialises in disruptive technology law. "For this token to be distributed on other markets, other national regulators will have to authorise it, not to mention the risk of requalification as we have seen in the United States", he fears.
According to our information, several applications have been filed by Backed in Europe. One of the most eagerly awaited applications for the DeFi ecosystem will be announced in a few weeks' time...
