Building Blocks of DeFi
The backbone of DeFI is what people call the “financial primitives.” These are protocols that offer lending/borrowing, interest (that compounds continuously), the economic return of assets, tranched risk — basically any financial product that can be created out of code. There are pockets of people all over the globe that are using open source code to build on top of what has already been built. Basically, anyone with an internet connection or a smart phone can join the party.
This is why financial primitives are also known as the “Money Legos” of DeFi, ie, the building blocks for future innovation of financial products. This is also known in DeFi circles as the “composability” of a protocol. Composability can simply be thought of as flexibility – how easy a protocol can connect with and interact with another protocol. The simpler the contract, and the more use cases that can be built with it, the more likely on-chain partnerships happen and more liquidity can build.
Let’s take a look at three different types of Financial Primitives and a protocol within that category.
Lend and Borrow – AAVE
Finance can be boiled down and understood as the supply and demand of loanable funds. Aave is an open-source, decentralized, non-custodial protocol on Ethereum that allows users to do those two things, supply digital assets and borrow digital assets. Users earn yield on digital assets supplied to the protocol. This yield will adjust automatically and algorithmically based on supply and demand within the protocol. Aave has the largest Total Value Locked (TVL) in DeFi, with over $15 Billion dollars locked in the protocol. Due to the open-source nature of Aave, there are other protocols that have successfully built on top of Aave, such as 88mph. This protocol isn’t only expanding within one blockchain ecosystem, such as Ethereum, either. Aave also operates on the Polygon and Avalanche blockchains. This is a great example of interoperability and composability for a financial primitive DeFi protocol.
Decentralized Derivatives – Opyn
Opyn, is a non-custodial and open-source options protocol that plans to capture value from the large amount of liquidity entering the decentralized derivative market. New applications can be built on top of Opyn – without needing permission or a contract. Ribbon Finance is a fixed-income protocol built on top of Opyn. Ribbon earns yield from selling options and packages those yields into other financial products. With these Money Legos, so many products can be built.
Synthetic Assets – Mirror Protocol
Global stock market value is approximately $100 trillion USD. About half of the total stock market value resides in the US equities, but only approximately 4% of the world’s population lives in the US. The rest of the world has no way to invest and share the risk/reward of US innovation. Mirror is a permissionless, open-source synthetic asset protocol built on the Terra blockchain. The protocol tracks the prices of “Mirrored” Assets so anyone with an internet connection could purchase a real world asset of their choosing. This is as primitive as it gets, buying and selling real world assets reflected on the blockchain. Innovation that can stem from this basic function is up to your imagination.
Basic functionality of finance is now code and anyone can build on top of it. Future of finance will be in the hands of enthusiastic developers creating products that excite consumers. Building blocks have been built and we are witnessing a Cambrian Explosion of financial products.
CrossTower Inc. provides this content for general information purposes, to better inform you on your digital asset investment journey. We do not provide investment recommendations or provide tax advice. Please consult your investment professional or tax advisor if you require assistance in these areas.
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