Decentralized Finance: Beyond Ethereum and Closed Financial Systems

As world governments have scrambled to deal with the COVID-19 crisis, many have resorted to imposing travel restrictions, lockdowns and mandating that businesses and workplaces close in an attempt to curb the disease.

The economic consequences of such policy decisions, especially for the poorest in society, is increasingly apparent. In the US, unemployment claims sit around the 800,000 mark.

In Latin America where 190 million people are living in poverty, the IMF predicts that the region will suffer the greatest economic contraction in the world.

How events play out from here remains to be seen, but the global financial crisis of 2008 offers some clues. As the prevailing economic climate worsens, banks become recalcitrant to borrowers, lending streams dry up, and loans are called in. Unscrupulous lenders take advantage, making hay even as storm clouds gather.

In less robust economies, US-dollar denominated debts devalue the national currency and even relatively wealthy people struggle.

For many, the most bitter pill to swallow is not the disease itself or any eventual medication to combat it, but the economic wrecking ball of virus-mitigation strategies.

One key difference then and now is bitcoin. It is widely believed that Satoshi Nakamoto developed the cryptocurrency as a response to the last financial crisis, and the technology has matured significantly in the interim.

Now the technology has its opportunity to shine as once again the legacy financial system is shocked to its core.

A stable store of wealth? 

One of the prevailing criticisms of bitcoin is that it is incredibly volatile compared to more established assets. This may be an accurate assessment in the most stable and robust economies of the past decade, but less so elsewhere in the world.

In countries such as Brazil, Argentina where the currencies have demonstrated significant volatility, adoption rates of around 16% tell their own story. In Nigeria the high cost of remittances has pushed a third of people into crypto.

The variation in currencies may also play a role in the popularity of crypto in the developing world. Users can easily acquire a wide variety of stablecoins pegged to major national currencies, with Tether’s USDT, Kava’s USDX and Circle’s USDC among the many options. Stablecoins also sidestep national capital controls such as those imposed by South Africa, which also has high crypto adoption rates.

An open financial system

Stablecoins also contribute to another significant development in the evolution of cryptocurrency – decentralized finance, or DeFi for short. Although some may dismiss it as a craze among ethereum fanboys, with some proponents creating complex chains of debts and providing liquidity as “yield farmers”, there is a deeper and more complex picture which emerges when you take a closer look.

For instance, DeFi can offer hope to the poor and unbanked. Over a billion people in the world remain excluded from traditional finance because they do not hold a government-issued ID.

With COVID-19 beginning to bite, the risk of the poor turning to loan sharks or other unscrupulous lenders also increases. DeFi provides an alternative for banking and for lending, and anyone with a smartphone and an internet connection can participate.

Two of the biggest players in the sector are Maker and Compound. In combination, anyone can deposit ethereum as collateral, issue a stablecoin loan, and stake it to earn interest.

Breaking the boundaries of Ethereum

DeFi has brought new challenges into the blockchain sector. Presently decentralized finance is heavily dependent on the ethereum blockchain, with the increased workload slowing down the network and making it more expensive.

The biggest problems of DeFi on ethereum is that: it is build on the unpopular programming language solidity, it has periodically high commissions, it is often overworked and overloaded. 

At times the ethereum network has struggled to process transactions for hours, and the price of doing so has been exorbitant. The development of new blockchains in tandem with cross-chain technology offers some ray of hope that the ethereum bottleneck may yet have a solution in waiting.

More ambitious projects that operate across multiple blockchains and with a more expansive range of features are now emerging. There are of course users of DeFi who wish for alternatives to Ethereum, cross-chain technology or not.

One project attempting to help cryptocurrency kick its dependency on Ethereum is PlasmaPay. Currently, an e-wallet for digital payments and e-commerce, as well as an exchange, the company aims to expand from their current offerings like borrowing, lending and their wallet app. They see their existing 100,000 customers in over 165 countries as a real competitive advantage over other blockchain entrants aiming to serve the DeFi space.

Anyone can build financial applications, in particular their DeFi projects, on top of the layer one Plasma blockchain. Perhaps what is key is that PlasmaPay is not only a fast (50,000 transactions per second) and free blockchain with no gas fees, but it also offers the infrastructure for cross-chain liquidity transfers and global fiat rails.

For comparison on bitcoin’s blockchain it costs from 2$ to 4$ for every transaction, on Ethereum it can be anything from 2$ to 15$ USD.

On current DeFi smart contracts it can be up to a few hundred dollars, depending on the complexity of the contract. Plasma charges no fees for Dapps because of their proprietary blockchain design and Proof of Stake consensus algorithm.

Unlike the majority of DeFi projects, they chose not to build on Ethereum. Think of it like the Apple Store, where distributed applications can be free. Apple provides the Apple Store infrastructure free of charge, just like PlasmaPay does for Dapps.

DeFi vs. traditional banks

When users decide to take advantage of DeFi loans, they will often find cheaper interest rates than are offered to them by banks or credit cards. As an example, someone who wishes to borrow Tether’s USDT or Circle’s USDC can get interest rates as low as 2.5% when using a DeFi protocol such as Aave. 

“For DeFi to truly fulfill its promise, it must end its over-reliance one on a single blockchain. Just as the limitations of legacy banking have fueled the rise of DeFi, the limitations of the Ethereum network will hasten the adoption of cross-chain technology.

One way PlasmaPay will play its role in strengthening the sector is by delivering the HyperLoop bridge protocol taking the strain from overworked networks. In this way more people can enjoy the superior DeFi experience with higher interest rates and payments to users, and break away from the outdated banking system which offers its customers very little in comparison”, Ilia Maksimenka, CEO and CO-Founder of PlasmaPay, told me in a recent interview.

“It is impossible to make as much return on your saving account deposits in the central banking system as you can possibly make on a decentralized banking system”, he added.

Even pre-COVID-19, the average lending interest rate in the US sat at more than twice that level, making a DeFi loan a potentially attractive proposition.

The infancy of the DeFi sector means that any discussion of it should be tempered with caution. That said, the availability of an open, inclusive financial system during the onset of a global recession is an intriguing prospect, particularly for those most vulnerable to financial shocks. As we stand on the brink of another world recession, the global pandemic could yet be the tipping point which sees the world rush into the warm embrace of cryptocurrency, blockchain technology and DeFi.

(Disclaimer: the author is a PR consultant for PlasmaPay)