Recurring market commentary on what's happening in the crypto markets, summarized by Crypto Finance AG Senior Trader Patrick Heusser.
How do I see the cryptocurrency ecosystem evolving? Especially when it comes to DeFi? And how do I label the various sectors and subdivisions?
Our Market Reports by no means try to be complete analyses of the crypto asset landscape, but they are my way of trying to keep up with all of the numerous developments, and document what I see as potential opportunities and possible shortfalls.
Today’s report is a continuation of my “five-year plan”, which I shared in a Knowledge Pooling Session with my work colleagues. You can listen to it here.
When imagining what the transition or merger of the TradFi (traditional financial) markets and the crypto DeFi (decentralised financial) market potentially might look like, there are some points that need to be taken into consideration.
Regulators around the globe have tried (and still are trying) to regulate crypto assets (especially bitcoin). Most of the more progressive governments and regulators have realised that the world has already reached the point of no return. They have “lost the battle, but not the war” – yet. They are now turning their attention to the next layer: the VASPs (virtual asset service providers). If governments cannot control the asset, they will try to control the capital flow by regulating the gatekeepers between the TradFi and crypto asset worlds. This includes DeFi.
Before we dive into the ecosystem, I would like to make a few general statements, and provide some links to the data sources I use daily.
First off, there are two sets of tokens that I consider relevant:
- Native tokens (the protocol has its own blockchain)
- ERC-20 tokens (ERC = Ethereum Request for Comment – 20 is the proposal identifier), which are widely used as the standard for smart contracts on the Ethereum blockchain
There are two main consensus mechanisms:
- PoW (proof of work)
- PoS (proof of stake)
It is very important to me to keep track of the categorisation of tokens using Messari. It helps me to see clearly the different sectors in this newly emerging DeFi universe.
- Application Development
- Asset Management
- Media and Entertainment
- Social Media
It comes as no surprise that most of the crypto asset and blockchain universe is all about transforming the financial market. The idea of bitcoin emerged due to there having been yet another financial crisis, and the core element (use case) is decentralised permissionless peer-2-peer payments (or value transfer). Another beautiful thing about this new ecosystem is that it is open-source. This is something that definitely helps to move new developments full steam ahead.
I believe that TradFi and crypto assets (including DeFi) will coexist with the support of VASPs, such as Crypto Finance, Sygnum, Seba, and Bitcoin Suisse, who act as gatekeepers of the capital that flows in and out (both coins and fiat). The set-up is not revolutionary. All VASPs do is enable a new asset class to TradFi companies, e.g. banks and asset managers. But it is an important role to play due to the fact that it clears the way for larger amount of capital from TradFi money, which can only move into the alternative sectors if regulated service providers can offer them a solution.
The revolutionary part is still in the making. The revolutionary part is what I call “giving the power and responsibility back to the investor”. In the DeFi space, you are the master of your wealth. There is no intermediary telling you what you can or cannot do with your money. It creates an equal playing field for large and small investors alike. Having said that, though, bridges from regulated VASPs to the DeFi sector have yet to be built. We can only interact with other centralised exchanges that fulfil the regulatory standard, allowing us to interact with them and move capital back and forth. As a regulated entity, it is not yet possible to interact with a DeFi protocol and move capital in and out.
The DeFi ecosystem
If you replace trusted central parties in an ecosystem, you need a clever concept to make the ecosystem work. This is especially the case in the financial sector, where flaws and/or inefficiencies are exploited very quickly. A blockchain or network (layer 0) plays a fundamental part in the new trustless ecosystem. Layers 1 and 2 are consensus and application presentations (like smart contracts). A blockchain is good at storing information, but poor at transferring it. This is an important point for two reasons:
- Smart contracts need input/information in order to be triggered
- There is no “main blockchain”: there are many, and they need to communicate with each other
Therefore, you can see that we need additional service providers to make the DeFi ecosystem valuable and useful. This is how I label the various service providers:
- Investment platforms (Aave, Yearn Finance, Compound, Alpha Homora, Cream, etc.)
- DEX (decentralised exchanges: Uniswap, Sushiswap, Curve, etc.)
- Oracles (Chainlink, Band Protocol, etc.)
- Insurances (NexusMutual, Cover Protocol, etc.)
- Multi or Crosschain protocols (Polkadot, Solana, Thorchain, etc.)
- Special services (e.g., Graph, which is a protocol for indexing and querying data from blockchains, starting with Ethereum)
But do you know what the true beauty in all of this is? If you want to interact with the DeFi ecosystem, all you need is a web wallet, e.g. MetaMask.
The different investment possibilities range from a simple asset swap on a DEX (e.g. swapping BTC for ETH) to complex investment strategies, e.g. on BarnBridge, where you can invest in different tokenised risk tranches (CDO tranches in TradFi). Again, nobody can stop you from investing. There are no minimum amount hurdles or agreements/contracts that need to be drafted by expensive lawyers in advance. However, it is at your own responsibility. And this means that you have to do your own due diligence!
Currently, the ecosystem is not close to being perfect or even really ready for the monstrous amount of capital that is currently in the TradFi ecosystem. But it does not have to be in my view: it does not have to be there yet. For me, this movement is a generational shift/change in how we take back power and responsibility of our own wealth. It will take time until the majority is ready to take on this power. Some may never feel comfortable with it. And this will allow the TradFi banks to survive. But to actually get to that point, we need a bridge that enables capital to freely flow between TradFi and DeFi. Therefore, we need regulators to dip their toes into this subject. A paper written by Prof. Fabian Schär is a good start. It was just recently published by the Federal Reserve Bank of St. Louis.
Additionally, it is fundamentally important that we see the development of CBDCs. In my view, CBDCs are one of the most misunderstood and polarising topics in the TradFi and DeFi (or blockchain) world. I will address this topic in a later report.
Open for discussion
I know that I have left out many topics, and I have not gone into great detail in terms of some of the statements I have made. This report is a “simple and dirty” view of how I see the current state of the crypto asset ecosystem with a focus on DeFi. I look forward to hearing your comments and remarks – especially if you disagree with me.
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