DeFi Beyond the Hype: The Emerging World of Decentralized Finance
A report produced by the Wharton Blockchain and Digital Asset Project, in collaboration with the World Economic Forum.
I apologize for the long hiatus. Over the last 10 months, I have been laser-focused on growing dYdX, a leading decentralized exchange providing advanced cryptofinancial products on the Ethereum blockchain. Over that time frame, dYdX has grown from $1B to $8B in transaction volume, raised a $10M Series B led by Three Arrows Capital / DeFiance Capital, and added tens of thousands of new users. More recently, dYdX launched decentralized cross-margined Perpetuals on Layer 2, powered by StarkWare. And there are many more exciting announcements in the pipeline.
Confused by what I just described?
In the recent bull market, many people in my network have reached out to learn more about blockchains, cryptocurrencies, Ethereum, and Decentralized Finance. I have a passion for sharing knowledge and writing but found that a weekly newsletter took too much of my time. I have focused my efforts instead on writing longer-form content.
For the last year, I've been working with a global team of blockchain and cryptocurrency experts, academics, and government officials on collaboration between The Wharton School and World Economic Forum, examining Decentralized Finance. I'm thrilled to announce the release of our first report, DeFi Beyond the Hype. This is my first public report as a lead author!
DeFi is a developing area at the intersection of blockchain, digital assets, and financial services. Over $80B of digital assets are locked in DeFi protocols, up from less than $1B a year ago. The potential of a disintermediated, fully digital financial system is exciting, but there are uncertainties, risks, and regulatory concerns. This project is working to provide clear, unbiased information on both sides of that equation.
Stay tuned for our DeFi Policy-Maker Toolkit, coming soon!
Thank you Kevin Werbach Sumedha Deshmukh Daniel Resas Christian Sillaber Teana Baker-Taylor Ann Sofie Cloots (PhD) Brendan Forster Jordan Lazaro Gustave Fabian Schär Lex Sokolin Sebastian Banescu Jacek Czarnecki Charles Dalton Joyce Lai Ashley Lannquist Xavier Meegan Sheila Warren & others for contributing to this report!
Happy learning!
Definancier is curated by:
David Gogel: Growth Lead @dYdX | Builder/Advisor/Investor | Advisor @Paperchain.io | Wharton MBA/BS/BA | fmr Associate @Techstars' Blockchain Accelerator, Co-president @Wharton FinTech, Corp Dev @LinkedIn @AIG
Follow me on: Twitter | LinkedIn | Definancier
DeFi Beyond The Hype Summary
Full Report available at: https://wifpr.wharton.upenn.edu/wp-content/uploads/2021/05/DeFi-Beyond-the-Hype.pdf
Historically, intermediaries have played essential roles within financial markets, serving as agents and brokers of trust, liquidity, settlement, and security. The range and value of intermediaries have grown over time to meet the needs of an increasingly complex financial system. Since the 2008 Global Financial Crisis, there has been increased attention on inefficiencies, structural inequalities, and hidden risks of the intermediated financial system. More recently, controversies such as the GameStop short squeeze, in which retail investors were blocked from trading during a period of volatility, cast a spotlight on other shortcomings of legacy financial infrastructure: slow settlement cycles, inefficient price discovery, liquidity challenges, and the lack of assurance around underlying assets.
Decentralized Finance (DeFi) is a developing area at the intersection of blockchain, digital assets, and financial services. DeFi protocols seek to disintermediate finance through both familiar and new service arrangements. The market experienced explosive growth beginning in 2020. According to tracking service DeFi Pulse, the value of digital assets locked into DeFi services grew from less than $1 billion in 2019 to over $15 billion at the end of 2020, and over $80 billion in May 2021. Yet DeFi is still early in its maturation.
DeFi is a general term covering a variety of activities and business relationships. We identify six major DeFi service categories —stablecoins, exchanges, credit, derivatives, insurance, and asset management—as well as auxiliary services such as wallets and oracles. While Centralized Finance (CeFi) relies on intermediaries to manage and process financial services, DeFi operates in a decentralized environment—public, permissionless blockchains—in which assets remain under user control. Services are generally encoded in open-source software protocols and smart contracts, which can execute transactions and alter position values algorithmically.
Like blockchain technology more generally, DeFi has an enthusiastic base of evangelists, who promote its potential for efficiency, transparency, innovation, and financial inclusion. It offers the potential for rapid innovation and the creation of new services for improving the efficiency of financial markets. Indeed, DeFi builds upon work being done in financial technology (FinTech) and leverages blockchain technology to facilitate alternatives to traditional service providers and market structures.
Within and beyond the categories described here, DeFi is evolving rapidly. Developers are experimenting with new services, business models, and combinations of DeFi protocols. Technologies are maturing. Services are moving to decentralized management and governance of protocols. Tools are emerging to simplify the user experience on and across DeFi services. A significant aspect of ongoing DeFi development will involve the composition of Dapps and financial primitives as “Money Legos.”
While DeFi is an exciting, fast-growing area, it also has its critics, risks, and unknowns. And indeed, there have already been significant examples of fraud, successful attacks, governance controversies, and other failures in the DeFi world. The underlying systems remain immature, with a variety of unresolved economic, technical, operational, and public policy issues that will be important to address. Although some protocols have attracted significant capital and the associated network effects in a short period of time, the DeFi sector remains volatile. activity to date has concentrated on speculation, leverage, and yield generation among the existing community of digital asset holders. The very flexibility, programmability, and composability that make DeFi services so powerful also expose new risks, from hacks to unexpected feedback loops among protocols.
While DeFi has the potential to revolutionize and democratize global finance, at this early stage, it is essential for industry and governments alike to develop a well-informed and nuanced understanding of the opportunities, risks, and challenges. Retail investors, professional traders, institutional actors, regulators, and policy-makers will need to temper enthusiasm for the innovative potential of DeFi with a clear understanding of its challenges. Developers are actively working to address vulnerabilities and introduce new mechanisms to manage risks efficiently, but the process is ongoing. DeFi will ultimately succeed or fail based on whether it can fulfill its promise of financial services that are open, trust-minimized, and non-custodial, yet still trustworthy.
Full Report available at: https://wifpr.wharton.upenn.edu/wp-content/uploads/2021/05/DeFi-Beyond-the-Hype.pdf
[i] We use the general term digital asset rather than cryptocurrency, virtual currency, or cryptoasset. Particular terms may have distinct legal meanings in certain jurisdictions.
[ii] Increasing digital asset prices contributed to this rise, but organic growth was also very strong. The number of DeFi wallets grew from 100,000 to 1.2 million during 2020, and new DeFi applications went from eight in 2019 to over 230 in 2020. Exclusive: DeFi Year in Review by DappRadar, The Defiant (December 28, 2020), https://thedefiant.substack.com/p/exclusive-defi-year-in-review-by-1f2.I apologize for the hiatus.