“We developed this protocol and made everything open source, so anyone could use our code and build on it, but there was no way we expected it to take off the way it has.”
With central banks plowing trillions of dollars into the global economy, inflating stock prices and depressing bond yields, the rush into alternative assets has prompted more than 700 new tokens to list in the last two months.
These have jump-started the otherwise sleepy decentralised finance, or DeFi, ecosystem underpinned by blockchain. And for some speculators has returned between 60 per cent and 100 per cent, says DeFi Pulse, a market aggregator website.
The DeFi crypto surge has been caused by the huge profits traders make using their crypto stash to provide “margin loans” that, in effect, supply the liquidity that power these DeFi systems. This is known as liquidity mining or yield farming.
These “margin loans” attract interest rates sometimes as high as 100 per cent, and the issuer of the loan can sometimes also clip the ticket on each transaction. Speculators are using these loans to bet on the direction of the market.
Just as during the initial coin offering (ICO) craze of 2017, which coincided with bitcoin’s meteoric price bubble and saw millions made and lost chasing the next bitcoin, stories abound of a fresh breed of “Robinhood” traders doubling and tripling their initial investments in the space of hours.
One such trader is Mark Anderson, who spends his days flipping his crypto-stash across tokens like Porkchop, SushiCoin and Pickle, earning interest by providing liquidity and sometimes collecting fees from those who use his stash to trade. While bitcoin is the most famous way to exchange value on a blockchain, an array of tokens exist, which can rise and fall dramatically in value.
“It’s been like Rambo in these markets,” Anderson tells AFR Weekend from his home in Newcastle. “In the space of two months, I’ve increased my stash four times just from yield farming in DeFi markets.”
“I can make money by offering my Ether stash as collateral for a new DeFi protocol so they can get up and running,” says Anderson.
“In return, I get an interest rate that can sometimes be 100 per cent as well as new tokens that I can trade.”
DeFi projects have been around for several years and, until recently, were not designed as tools for speculation. Services typically focus on areas such as borrowing and lending, insurance, margin trading and exchanges. All of these decentralised applications aim to strip out any central parties, replacing those traditional middlemen with software that executes transactions automatically when programmed conditions are met.
Melbourne-based Mutual Nexus offers decentralised insurance contracts, programmed to pay out should software fail or criminals steal assets, and has attracted over $US80 million in circulating money.
Compound, meanwhile, is one of the more advanced DeFi protocols, and runs a lending and borrowing platform, offering interest rates and fees for participants as well as COMP coins, providing holders with “voting rights” on how the system should be governed and maintained.
Just like futures contracts, these can be traded, and the value of COMP coins has more than doubled in value since June.
“These systems are designed for those with crypto-wealth to operate and use traditional financial tools without the need to intersect with banks or brokers,” says Henrik Andersson, chief investment officer at Apollo Capital in Melbourne, and an early DeFi investor.
“If designed well, participants don’t need to trust a bank or a third party, they just need to trust the software.”
Andersson explains the tokenisation of these services has also introduced a type of decentralised governance, which looks like a representative democracy, and enables community management.
But whether or not the flurry of new DeFi projects are designed well enough to actually provide a service people will want to pay for in the long run is up for debate.
YAM tokens attracted more than $US500 million before a bug in the smart contract prompted the project to collapse, and Yfdex. Finance’s founders made off with $US20 million after launching their liquidity mining pool.
While some ICOs worked earnestly to develop new ways of using smart contracts and the blockchain, the vast majority took advantage of the exuberant and greedy market, committing widespread fraud and often outright theft.
Vitalik Buterin, founder of the Ethereum network on which most of these protocols are based, said recently: “I personally am steering clear of the yield farming space completely until it settles down into something more sustainable.”
While traders like Anderson don’t want DeFi to settle down, the recent frenzy has seen a correction, with median DeFi asset prices down 10 per cent over the last seven days, DeFiPulse data shows.
“I hope the market is just taking a breather,” says Anderson. “But if not, the DeFi protocols will keep coming as people work out other ways to decentralise finance.”