• Decentralized finance has caught the imagination of investors
  • DeFi seeks to disintermediate finance
  • Innovation in peer to peer lending has created a vibrant marketplace for loas
  • Aave is one such start-up that is offering market beating yields
  • DeFi is providing excess profits for early adopters

Decentralized finance has caught the imagination of investors

Decentralized finance or DeFi as it is known has become the hot new thing as both investors and entrepreneurs are rushing to capitalize on the new technology that promises to transform investing as we know it.

DeFi seeks to disintermediate finance

The central premise of DeFi is disintermediation. The aim of DeFi  is to bypass intermediaries such as banks, exchanges, brokers who currently enjoy rentier profits from bloated user fees and make finance such a prime target for disruption. 

Last summer many of the key applications in DeFi became popular and the total value of transactions in the sector skyrocketed from a few million dollars to nearly 10 Billion dollars today. In the grander scheme of things this is still  a tiny fraction of the global finance industry but the meteoric growth rate has caught the imagination of investors  who see the enormous  potential of the technology.

The architecture of decentralized finance rests on the Ethereum blockchain which allows for the creation of smart digital contracts. But to access the potential profits of these new financial products investors have to convert their fiat currency into a bewildering array of new digital currencies some of which have stable relationships with the US dollar and some of which fluctuate wildly in their value. The process is neither fully intuitive nor completely safe (lose your password and you’ve lost your money – just like with cash), but it has become a lot more user friendly than in the past and there are now a myriad of websites that offer the ability to create a digital wallet which is step number one for anyone looking to profit from new investment opportunities in DeFi.

Innovation in peer to peer lending has created a vibrant marketplace for loans

Once you’ve converted your fiat into digital assets you may want to consider the space of peer to peer lending as the simplest way  to earn a yield on your savings. The great innovation in decentralized finance was to eliminate the whole concept of peer to peer lending which requires two separate parties to come to bilateral terms on the borrowing arrangements and substitute it with a peer to smart contract model. In this new model lenders and borrowers do not lend or borrow against each other but against a contract that updates interest rate terms in real time based upon supply and demand conditions. That has eliminated the need for counterparties and has made the process much more seamless and instant as borrowers and lenders simply act against the prevailing market rate which in the case of peer to peer lending can offer yields of anywhere between 300 to 900 basis points on short term duration notes – considerably higher than corporate or US treasury securities.

Aave is one such start-up that is offering market beating yields

One such business that has seen exponential growth this year is AAVE, a Finish start-up that offers a variety of peer to peer investment products that are collateralized offering security for the lender. Unlike centralized finance marketplaces that often gate the entry by requiring minimum investment deposits, the DeFi space allows for investments as small as a dollar but as always there is a catch. Although DeFi is decentralized and permissionless there are still user fees and in the case of the Ethereum  protocol on which all of these smart contracts are based the costs have skyrocketed to $100 per transaction making it financially non viable to explore DeFI peer to peer lending unless you have savings of $10,000 or more. 

To address this issue Aave is now trying to create a sidechain called Polygon that would bypass the Ethereum transaction fees but would still be compliant with all the safety protocols and would allow the contracts to be ported back onto Ethereum at a later date.   

DeFi is providing excess profits for early adopters

Although crypto remains the wild wild west of finance it is precisely this flexibility and speed of innovation that makes DeFi such an interesting and compelling investment space. The nascent sector will need to become a lot more user friendly before wide adoption can take place, but the current climate provides extraordinary profit opportunities for savers looking for a significant return in a yield starved world so at very minimum it’s worth an exploration with some risk capital before an Aave transaction becomes as mainstream as a passbook savings account.