What is the fastest growing sector of the crypto-verse? If the amount of virtual newsprint devoted to touting Decentralized Finance (DeFi) is an accurate measure, then DeFi projects are hands down the winners of the hottest arena in crypto in 2020. Venture Capitalists (VCs) are already on record for jumping into the space big time in 2019, something reminiscent of Internet funding of old, where capital was thrown at any Internet idea on a piece of paper. Estimates are that nearly $700 million was invested in a myriad of initiatives, but that as much as $5 billion could be put to work in 2020.
The amount, diversity, and immediacy of activity in this arena have been astounding. Big bucks are searching for the “Gold Ring”, so to speak, as to which service approach will deliver the biggest bang per dollar invested, a competition that typically results in a major consolidation down the road. There will be winners and losers. The projected revenue streams are not enough to provide substantial returns for all investments. Translation – Someone will get it right, and a lot will perish searching for a winning formula. The following graphic from The Block is a dilution of the efforts, but it reveals the chaos:
Why is there so much widespread interest? For the moment, the market cap of crypto token systems is roughly $200 billion, with an accompanying debt-to-asset ratio estimated to be 2%. If you add together the global stock market ($85 trillion) and real estate market ($217 trillion) and put global debt ($244 trillion) as the numerator, you will get a rough debt-to-asset ratio of 81%. Looks like crypto has quite a ways to go to play catch up, or at least opportunists see it this way.
Whatever may transpire over the next few years, the volatility of cryptos will limit the actual amount of loans by requiring more collateral on deposit. Experiences to date have primarily been with exchanges providing margin credit and funding those credit lines via approvals from other depositors for the use of their balances. The plethora of companies depicted above, however, is not interested in this rather targeted and somewhat limited opportunity. If the global economy thrives on “leverage”, then why not Crypto?
Analysts at CoinTelegraph put it this way: “Crypto lending works similarly to traditional lending services, the core difference being that loans are issued on decentralized platforms that lock up cryptocurrencies via smart contracts deployed on public blockchains. And while the up-and-coming decentralized finance sector has grown, with $452 million in funds locked up in smart contracts — a 200% year-on-year increase — the industry has the potential to reach higher adoption levels.”
The challenge, however, will be the current mismatch between cryptos and fiat currencies from a volatility perspective, which adds a decisive risk element to the equation. Per Cointelegraph again: “We can’t forget that the smart contracts that power crypto loans are self-executing lines of code. Securing a loan would involve sending cryptocurrencies to a smart contract escrow on the blockchain that will only release the collateral when the debt is repaid. This means that movements in the value of a cryptocurrency in relation to a fiat’s value could trigger the smart contract to liquidate a loan.”
Within the current milieu, where lies the greatest opportunity for success? Cointelegraph surmises that a Euro-based stablecoin has great prospects in this arena. Stablecoins to date have predominantly been USD-backed, but the EU crypto market participants actually outrank the U.S., if you compare statistics. Per CCN: “9% of Europeans own crypto (67 million people) compared to 8% of Americans (26 million people).” These Europeans must also settle in USD, a cumbersome process with added FX risk. There is also the additional incentive that negative interest rates provide. They encourage savers to join the wave of DeFi investment products on the EU horizon.
Of course, it is not as easy as picking a Euro-based stablecoin and running to market. Yes, the blockchain and smart contracts can handle much of the load, but an entirely new infrastructure base must be built to handle credit monitoring, reporting, and collections, the traditional risk mitigation tools in the lending profession that any potential investor would expect before investing or tying up funds. Any program, by necessity, would also need on- and off-ramps to local fiat currencies, which may involve the major payment associations like Visa and MasterCard.
The folks at Cointelegraph conclude with these remarks: “With the crypto lending market growing at an astounding rate, it is guaranteed to disrupt the traditional finance sector even further. But for it to make a meaningful and long-lasting impact, a real stability of the underlying asset is a must. Fiat-backed stablecoins might just be the right solution. Among the hundreds of announced projects, EURS is the only game-changer that is crafted with regulations and still working successfully.”