DEFI (Decentralized Finance) is emerging as one of the “killer apps” in the cryptocurrency space. More importantly, it is not just a single app, but rather a series of apps, smart contracts and protocols that are trustless and secured by maths. More importantly, you retain control of your assets and there is no central company that holds these assets.
The current leaders in this space are Compound and Maker DAI protocols. Both protocols offer different market solutions and take advantage of the high volatility in the cryptocurrency market.
Compound is a pooled lending protocol that allows individuals to supply USD pegged cryptocurrencies to the protocol to earn a return with the need to trust a 3rd party. Individuals can also borrow against the protocol at a rate that derives from the lending demand. To borrow, individuals must put up 150% collateral in the form of another cryptocurrency. As the demand for lending increases the interest rate for the lenders and borrows increases and there is usually a spread of 2-4% from the supply to borrow side. The market that compound serves tends to be traders that want to use leverage in their trading strategy. More importantly, there is no company to run off with your money and the over-collateralization ensures there are enough assets to pay the lenders back.
https://app.compound.finance/borrow
On the other hand, there is Maker DAO’s market solution that is designed to be a token called DAI that maintains the same purchasing power as the USD but is not backed by USD in a bank. The protocol functions similarly to the Federal Reserve System, where the Maker DAO’s token market cap is the lender of last resort to the DAI system and DAI is lent into existence. However, instead of being backed by Debt, DAI is backed by assets like Ethereum and other tokens that are voted on by Maker token holders to be part of the protocol. DAI is created when individuals supply Ethereum to the protocol. Once supplied, individuals can mint DAI up to the amount that maintains at least a 150% collateralization ratio. For example, if you supply 150 USD worth of Ethereum you can mint up to 100 DAI which is worth 100 USD.
The value of DAI is maintained by arbitrage market forces and the Maker token holders who vote to either increase or decrease the Interest rate to encourage the creation of more DAI (if DAI becomes worth more than a USD) and burning DAI (if DAI becomes worth less than a USD).
There are many other protocols that are emerging as well such as Synthentix, Aave, and Kyber. Understandingly, the above is complicated for the average person to comprehend. To get exposure to this section without the complication there are a couple of apps I would recommend Dharma (dharma.io) and Argent wallet (argent.xyz).
These tools allow you to simply transfer USD from your bank account into a stable cryptocurrency such as USDC or DAI that maintains 1:1 peg with the dollar. You can then set how much to put into a savings vehicle that earns a variable rate from 2-12% depending on current market rates.
While it seems too good to be true, one needs to realize that these interest rates are based on supply and demand in a free market. The world has grown used to a centralized system that has artificially low-interest rates (natural interest rates over time have typically been between 4-10%, just look at rates prior to the 2008 financial crisis). These protocols offer a way for skilled leveraged traders to take loans from a p2p money market pool in the volatile cryptocurrency market that is ever-increasing in value. These protocols are overcollateralized requiring the borrower to place a cryptocurrency asset as collateral; if they do not repay the borrower is liquidated to ensure the stability of the system. This translates that volatility into simple savings accounts for the average individual. That is not to say there is no risk, the main risk as with any cryptocurrency is the risk of a flaw in the smart contract that manages the protocol. So as with any investment do not place your whole portfolio in this sector but start with a very small percentage is a good way to learn and get started.
More info on DEFI can be found here: https://defiprime.com/