What Emerging DeFi Technology Trends to Watch

As an advisor learns about decentralised finance (Defi), it’s important to learn about the emerging technology also found in the industry. Emerging Defi technology and services are unique to cryptocurrency, as some of these products and services simply are not possible without blockchain technology. This is an entirely new asset class, and advisors must be educated on these topics and able to clearly help their clients when faced with financial planning decisions. Clients will rely on advisors as they attempt to navigate this space, and advisors must be able to guide them down the best path. In the first three parts of this series, we’ve covered the basics of Defi, including its importance in the overall crypto economy, what decentralised exchanges (DEXs) are, and the technology behind them. This article originally appeared in Crypto for Advisors, Coin Desk’s weekly newsletter defining crypto, digital assets, and the future of finance. Sign up here to get it in your inbox every Thursday. What are crypto bridges? One of the more difficult aspects of investing in cryptocurrency is navigating the many different blockchains that exist in the crypto economy. Coins and tokens native to one blockchain are not able to be used on another blockchain. For example, you can not use Ether or ERC-20 tokens on any other chain besides the Ethereum chain. This presents a problem because, often, investors see an opportunity on a new blockchain and therefore need a mechanism to send value (coins or tokens) from one chain to another. A user can send value from one blockchain to another chain, such as from Ethereal to Terra. There are two types of crypto bridges: trusted bridges and trustless bridges. Trusted bridges are centralised by design—that is, they require users to trust a central party for custody and transactions. Fewer trust bridges operate using smart contracts and trading algorithms and do not require users to trust a central entity. It’s important to understand the risks while using crypto bridges. When using a trusted bridge, the risks are similar to those when using a centralised exchange or wallet. Custodial risk is the risk users face when they allow a third party to hold their tokens and coins. When coins are held in a custodial account, the user is also susceptible to censorship risk. Many users are comfortable with these risks, while others prefer to use trust-less bridges. These bridges, on the other hand, do not require users to trust custodians or worry about censorship; they do, however, require users to trust the smart contracts that power the bridges. The largest hacks in crypto have come from crypto bridges. This technology is new; even just a few years ago, there was not yet a market demand for cross-chain bridges. Developers have been building crypto bridges quickly, and unfortunately, not all of the security vulnerabilities were found via code audits. It’s certain that the security of these bridges will improve as they become more widely used and built, but users must be very careful while using them now. It’s important to remember that bridges are an emerging technology and, in their current state, are not entirely free from risk. Understanding self-repaying loans One of the most interesting features of digital money is the ability to create new technology and use cases for blockchain technology. Self-repaying loans are one of the most innovative new ideas found in Defi. Essentially, when a user takes out a self-repaying loan, they are using the yield on a deposit to pay for a loan they’ve taken out against that deposit. In order to take out a self-repaying loan, a user first deposits capital into a protocol like Alchemic, which allows you to borrow up to 50% of your deposit instantly. This is possible because of the high yields found in crypto lending. The 50% of the deposit that stays in the protocol is used to pay back the 50% that was taken as a loan. As the principal pays back the borrowed money, the rate at which the loan is paid back accelerates. To understand this, let’s walk through an example. A user holds DAI, a stable coin, in their Metalmark wallet. The user connects their Metalmark wallet to Alchemic. The user deposits DAI into Alchemic via the website and can immediately borrow up to 50% of the deposited funds via the alUSD (Alchemic stable coin). The user can then sell their altus for fiat currency, ether, or other cryptocurrencies. The DAI, still held by Alchemic, is left to generate a yield (approximately 10-15% at current rates) and pay down the balance of the loan. As the balance of the loan gets smaller, the balance of collateral is increasing. The interest rate is static; thus, the rate at which the balance is paid down accelerates.