Decentralized Finance or DeFi comprises peer-to-peer financial services that use blockchain technology and eliminate intermediaries such as banks that make up the traditional financial system (TradFi). It has several advantages over TradFi, such as faster transactions, greater transparency, and streamlined cross-border transactions, among others.
The Ethereum blockchain is home to the most number of DeFi projects, contributing to nearly 55% of the total value locked (TVL) in DeFi as of May 2022. Developments in blockchain technology have allowed for the creation of decentralized apps using smart contracts, which have, in turn, enabled DeFi. However, a high volume of activity has strained Ethereum, resulting in slower processing times and steep transaction fees. Planned upgrades to the chain, along with new blockchains emerging with innovative processes and interchain compatibility, are set to bring about more efficiencies in the space.
The search for high yields is the primary driving factor for this sector, as investors seek to generate returns that have consistently outperformed traditional investments like treasuries. In addition, a sizable underbanked population and difficulties faced by SMEs in obtaining credit are likely to drive demand for credit through DeFi applications.
Most startups in the DeFi space operate in the borrowing and lending segment, while much of the incumbent activity is seen in the marketplaces and wallets segments. The incumbents are mostly established cryptocurrency exchanges as most DeFi projects also operate in the same blockchains as major cryptocurrencies. These incumbents mostly have internally developed solutions to expand their existing marketplace and wallet offerings to support DeFi protocols, enabling access to tokens from DeFi projects such as Compound, from the borrowing and lending segment.
While limited, the infrastructure segment is also seeing activity from traditional banks, as they experiment with blockchain technology in their own internal processes or to trial DeFi projects. Another notable incumbent is the Ethereum Foundation (a non-profit dedicated to supporting the Ethereum blockchain), home to the most number of DeFi projects. Startups in the infrastructure segment have garnered the most funding as Ethereum-challengers emerge, offering high performance at a lower cost.
Most disruptors operate as decentralized autonomous organizations (DAOs), a non-hierarchical governance structure where holders of the DeFi project’s native token are able to vote on strategic and operational matters of the DAO. Further, given the relatively young age of the disruptors (and the industry itself), most DeFi startups are at an early/seed stage.
Most startups in the DeFi space are involved in the borrowing and lending segment, and are built on an existing blockchain such as Ethereum. The blockchain landscape and cryptocurrencies, in general, have seen phenomenal growth during the last two years. The DeFi sphere has been no different. Around 40% of the key startups in this space were established after 2020, with nearly 90% of them being founded during the last five years.
Crypto-backed borrowing and lending platform for institutional investors Anchorage Digital is the largest funded disruptor in this space, having closed its Series D round of USD 350 million in December 2021. However, companies in the infrastructure space have raked in the highest total funding, with Ethereum-challenger blockchain Solana leading the pack with over USD 335 million in funding as of May 2022.
While established investors such as Andreessen Horowitz have amassed a notable portfolio in this space, most DeFi projects, given their DAO structure, also see significant retail participation in their coin offerings, in some cases attracting thousands of investors for a single offering.
BlockFi offers a US-regulated borrowing and lending platform that allows users to take out USD loans collateralized by cryptoassets. In addition, the company also offers personalized yield aggregation solutions for users that commit at least USD 3 million in loaned cryptoassets on the platform as well as a dedicated wallet for users to buy, sell, and store crypto. Notably, its yield aggregation product offers a designated client relationship manager that provides users access to negotiated crypto interest rates, competitive trading costs, term or open loan structure, and customizable term length.
As of June 2022, the company served over a million users from over 350 institutions around the globe.
Funding and financials
In August 2021, the company was in talks to raise USD 500 million in Series E funding at a valuation of USD 5 billion. As a result of the crypto market crash in June 2022, The company was reportedly looking to raise funding in June 2022 with Bain Capital Ventures being tipped to lead the round. The expected valuation for this round was around USD 1 billion, which was only 20% of the expected valuation from an earlier Series E negotiation in August 2021. This was largely due to the drop in the crypto market during the first half of 2022 and overall depressed markets during the same period.
In July 2022, FTX signed a deal that includes an option to buy BlockFi , a DeFi borrowing and lending platform, for up to USD 240 million. Additionally, FTX also provided BlockFi with a USD 400 million revolving credit facility, which will be subordinate to all client funds. In November 2022, subsequent to the collapse of FTX, BlockFi filed for Chapter 11 bankruptcy in the U.S. Bankruptcy Court for the District of New Jersey. The company stated that it made the filing to “stabilize its business” and enable it to come up with a comprehensive restructuring process for its clients and stakeholders. Blockfi went on to state that it had USD 256.9 million in cash on hand which will be used to provide liquidity for selected operations during the restructuring process.
Borrowing and Lending:
As most DeFi projects are based on the same blockchain as popular cryptocurrencies (such as Ethereum), established cryptocurrency exchanges such as Coinbase and Binance can expand their offerings to cover DeFi-related projects with relative ease. These exchanges are using their existing marketplace offerings to allow users to swap DeFi-related tokens, hold them using the same wallets as their crypto, and even provide direct access to deposit their tokens into yield-generating tokens like DAI from MakerDAO.
Traditional banks are yet to fully break into this space, as they are restricted by their internal compliance measures and an overall risk-averse approach to innovation. However, large international banks (such as JPMorgan and ING) are taking steps like experimenting with blockchain in their internal processes, working on building the infrastructure to develop apps on top of it, and testing peer-to-peer DeFi protocols in regulatory sandboxes.
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