This week, Dani and Ned find out more about Decentralised Finance (DeFi) with Edmund Lowell.
To understand the difference between DeFi and traditional finance, Edmund introduces an analogy. In traditional finance, when we need a loan from a bank, we have to put up an asset such as our home as collateral. Once the loan is paid, our assets are released. In a DeFi space, a similar process occurs using cryptocurrency. Instead of locking our physical assets as collateral, our digital assets like Bitcoin or Ethereum are locked up to take out a loan. This loan takes the form of ‘DAI’, a notably more stable form of cryptocurrency, and is equivalent to a US dollar. Much like traditional finance, when we return our loaned ‘DAI’, our digital assets will be unlocked. The difference is DeFi is a permissionless and decentralized space, meaning that anyone can participate.
Now we know that anyone can participate. But why would anyone want to? Firstly, Edmund explains that there is an inherent curiosity surrounding new assets. It is not often that a new asset class like cryptocurrency is invented, which gets people excited. Secondly, the main reason why people participate in cryptocurrency is because of the yield. Compared to what is available within the traditional finance space, cryptocurrency offers much better returns. One can speculate on Ethereum or Bitcoin which generate incomparable returns to traditional assets. Another opportunity for investment that DeFi has enabled is investing in something similar to fixed income which is a lot less risky. The degree of risk surrounding DeFi is challenging to assess as it is dependent on which platform is being used. This is why Edmund developed a product known as Selfkey, which compiles a loans marketplace. This feature allows users to compare across the different lending platforms and find out critical information like risk levels and interest rates.
Finally, DeFi presents an opportunity for those with fewer finances to get a loan at a minimal cost. In countries with a collapsing local currency, residents will be able to enter the DeFi space and invest in a more stable coin. For countries with efficient financial systems like Singapore, this might seem less important. But for those who reside in countries with inadequate financial systems, DeFi enables them to hold onto currency that is not tied to the sovereign success of the country. Thus, peace of mind is offered through the safety of investments.