Early this year, I shared about how I earned interest on USD stablecoins on BlockFi. Unfortunately, BlockFi subsequently experienced a minor hack in May thanks to “social engineering”. While assets and passwords were not stolen, customer personal data was. This event got me thinking and researching about viable alternatives for my stablecoins. This brought me into the land of Decentralised Finance (DeFi), an ever growing group of cryptoassets that hopes to disrupt the traditional financial system by cutting out the middleman.
As with anything that I invest in, I jumped in head first with some money to learn as I go while slowly committing more as I understand about it more. It’s been 2 months and its been an incredible learning experience. As I imagine most of my readers to be traditional investors, I hope to share some of the lessons I’ve learnt, implications of DeFi and hopefully raise awareness in the process.
What is DeFi?
To me, Decentralised Finance is a very vague term. Anything that is decentralised and with a finance use case can be considered DeFi. Bitcoin could be described as the original DeFi token as it is a currency that has no centralised governing body.
That said, DeFi projects mostly relate to various applications built on Ethereum that provide similar functions to various players in the traditional finance world (banks, exchanges, insurance providers, etc). Some examples of what you can do in DeFi include:
- Earn interest on deposits and collateralised loans: Compound, Aave
- Automated market making: Uniswap, Balancer, Curve
- Options and Insurance contracts: Opyn, Hegic Options and Nexus Mutual
- Derivatives trading: Synthetix
All these sound like functions already provided by the traditional financial system. Why should I care about this?
The key difference here is that there is no middleman, just a smart contract governing each function. The beauty of this is that you don’t need to undergo any KYC, listen to any bullshit from an agent or see your money diluted due to Jerome Powell central banks printing infinite amounts of money.
Oh and if you’re savvy investor, there are plenty of ways to make money in the DeFi space due to all the incentives being distributed at the moment. The annualised returns can be quite ridiculous with double digit annualised returns being quite common place in the space. To find out more do your own research 😛
For a decent introduction to the space, here’s a decent youtube video I found explaining some of the concepts and risks with the space. I don’t agree with the coins shilled by the youtuber though haha 🤣
Many lessons
In the spirit of crypto twitter memes, here are some lessons I’ve learnt illustrated via memes as far as possible.
Complex and dangerous AF
Crypto and DeFi has more coins in existence than Street Fighter characters. Researching and understanding the use case and functionality of all these applications will take a hell lot of time and energy.
Also, DeFi presents many strategies to earn yield on your assets. Basic strategies include simply depositing assets in a specific place to earn yield. Advanced strategies involve taking advantage of all the incentives being thrown around in the space while using leverage.
Lastly, DeFi is in such a nascent stage of development that some protocols have a bare bones UI or employ a convoluted deployment approach that even using the product requires 200 IQ. The tweet above is one such example.
Advanced DeFi yield farming strategies take time and effort to learn and deploy, not something for your average Uncle and Auntie to play around with blindly.
That said, there in lies the opportunity for savvy investors to earn the alpha. Certainly worth the effort so far for me.
Like drinking from a fire hydrant
Keeping up with DeFi changes can be almost a full time job. Things can change overnight such that you will need to make quick decisions to swap your assets in and out of protocols. Between crypto twitter, telegram groups and Discord servers, the sheer volume of news can keep you occupied 24/7.
Add all the announcements and governance proposals to sift through for each application, one might be forgiven for suffering whiplash. That is the cost of admission should you choose to play the game responsibly. If not, you’re exposing yourself to risks that you do not know about.
Fees can kill you
Transaction fees (known as gas fees) on the Ethereum network is dependent on the demand by users and complexity of the contract. Those willing to pay more gas get their transactions processed and verified first.
The surge in demand due to DeFi has pushed transaction costs through the roof. Imagine my surprise when I was playing around with 1 of the hot DeFi applications when I saw the amount of gas required to process the transaction.
While the above is an exception rather than the norm, the network nickels and dimes you a lot if you make a lot of transactions. This means that you need to put substantial money behind every trade to make the gas fees worth it. This is an inherent problem with ETH at this time, something that will hopefully change when Ethereum 2.0 rolls out, if it does.
The only way to mitigate cost is to be very thoughtful in what and when you transact. What you buy and sell depends on your fundamental knowledge and research on the various products. When you transact is easy – wake up early to transact. Demand is naturally lower when less people are awake.
Dumb money everywhere
As with any financial product offering ridiculous returns, people are just throwing money to chase these returns. Total Value Locked (think of it like AUM) in DeFi has tripled in the past 3 months to USD 3 billion.
Based on the surge in questions and comments I see on Telegram and Discord, I can see a ton of people asking very basic and ignorant questions. They probably are unaware of the risks of investing in various products.
Well this presents plenty of opportunities to make money trading against these fools, I am concerned with the building froth in the space. Be careful if you choose to participate and understand the risks involved.
Implications for my portfolio
At this point, I’ve withdrawn some funds out of my traditional portfolio to augment my crypto portfolio. I’m still debating whether to include my crypto holdings as part of my monthly portfolio update. I’m leaning towards not doing so as like I said, crypto dangerous AF and I dont want people to follow me down a dark road to be ambushed.
Do feel free to reach out via email though if you have any questions.
Final Thoughts
DeFi in its current form is already fascinating. Everything is conducted on-chain without a need for intermediaries like banks and stock exchanges. It begs the question of why we even need these centralised bodies in the first place. I feel that these institutions need to recognise this threat and evolve to stay relevant. Something for traditional investors to watch out for and think about.
The DeFi ecosystem is far from fully fleshed out with so many possible applications being developed and refined. Also at this time, DeFi is playing out largely on Ethereum and I’m excited to see more blockchains come up with their own DeFi applications.
Despite the surge in interest, I feel we are still early in the DeFi bull market as $3b AUM is nothing compared to the traditional financial system. Whether this comes to bear, we shall see.
Happy Hunting,
KK
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Hi KK,
thank you for your article. After reading your post and seeing what one can do with DeFi, I totally agree with the last section, where you mentioned that “institutions need to recognise this threat and evolve to stay relevant”. Maybe one could argue that they stay relevant as they are more regulated and, thus, financially-illiterate investors are more “limited” in the mistakes they can make.
Beyond, I’m working in FinTech but not in the DeFi sector, and I would be interested to learn more about DeFi. Do you have any good websites or YouTube channel to recommend? (apart from the one of the above video)
Hi Emma,
Wow interesting to see that the DeFi revolution has begun reach the ears of institutional funds.
Regarding your comment on regulation as a way to stay relevant, in a DeFi world where functionality is automatically provided by smart contracts with everything verified and secured by the blockchain, there is minimal need for regulation and intermediaries. A lot of overhead could be cut out. You’ll probably only need regulation for the fiat on and off ramp to ensure no illicit funds enter or leave the system, which can be easily verified by analysing the blockchain. That’s the potential threat I see. Of course Governments can always take the radical view of not engaging with the system, which I think would be an inefficient outcome for these countries.
Regarding your request for resources, for basic tutorials on using the various protocols I think DeFi Dad is pretty comprehensive. As for DeFi specific analysis, I don’t personally use or follow any. The space is pretty nascent so I do most of the research legwork and experimentation myself. The best way to learn for me was to dive head first into crypto twitter and learn from there. Understand early adopters’ arguments for and against certain coins, verify and form your own opinion.
Good luck.
Regards,
KK