DeFi Summer is here, and wise investors are funneling money into coins and tokens associated with decentralized finance. In fact, DeFi markets have seen unprecedented growth in 2021, and they’ve sent investors on a search for the best DeFi projects of the year. But despite all the hype — and real potential — many still don’t understand what DeFi is all about.
DeFi refers to a conglomerate of financial applications anchored to blockchain technology. Through DeFi, banks can offer traditional financial services in ways that are more private and more beneficial to lenders and borrowers. And, it all comes with the benefit of being reported to a permanent digital blockchain ledger.
While individuals can take advantage of DeFi, many may feel overwhelmed. There are so many applications for DeFi technology, one might not know where to begin. This creates a barrier to entry. This isn’t a feeling reserved for individual investors, either; institutions who want to take advantage of these tools can look at it the same way. This has led to the creation of DeFi institutions like Anchorage Digital.
Anchorage Digital, co-founded by Diogo Monica, is the first federally chartered crypto bank. It continues to blaze new trails by aggregating top DeFi projects for institutional investors. And since its founding as a custodial service in 2017, Monica’s crypto bank has branched out to offer all sorts of other services, including governance, lending and financing.
Why Are Banks Turning to DeFi?
Thanks to the economic recovery effort in the United States, DeFi is more appealing than ever. Institutions are adopting DeFi and turning to Anchorage because the products it offers generate higher yields than traditional services. In the wake of the Covid-19 pandemic, the Federal Reserve has taken to buying Treasury securities and mortgage-backed securities. The emergency spending is creating a market ripe for riskier investments.
The Fed also has lowered its Fed funds rate to 0% in the wake of the pandemic, where it has been since March 2020. As such, banks have made no money on interest in this time. With DeFi, banks can make up to 7% on lending, according to Monica. It’s a no-brainer, then, that institutions want to turn to this market.
“[Institutions] would like to generate yield that ensures they will still have dollars, eliminate price exposure, and beat inflation itself,” Monica says of Anchorage’s clients.
But, for many, DeFi is difficult to embrace because it’s just so overwhelming. What makes these DeFi products different from traditional banking services? And why is DeFi summer worth adding to your calendar?
If you’re looking for answers to these questions, you’re in luck. Monica shared with InvestorPlace what he sees as the most exciting corners of the DeFi market. As you spend August cooling off at the beach, consider dipping your toes into these five top DeFi projects.
Top DeFi Projects 2021: Native Lending Tokens
According to Monica, one of the top DeFi projects is native lending tokens. Lending cryptocurrencies, as their name implies, allow lenders to passively farm income. At the same time, borrowers can use their crypto investments in real-world capacities. Using these currencies, somebody can use their crypto staking to take out a loan on a house, without having to sell off their holdings for fiat. Anchorage hosts support for a variety of lending cryptos that fuel much of the bank’s day-to-day use cases.
Monica says the decision to offer lending tokens came down to simple client demand. “[Institutional clients] had billions in assets on Anchorage,” Monica says, “How do they generate yield off of their assets? Can they do it through one counterparty?” Of course, the crypto bank’s answer was a resounding, “Why not?”
Now, the bank provides lending using tokens like Aave (CCC:AAVE-USD) and Compound (CCC:COMP-USD).
This type of token offers up lending opportunities that closely mirror traditional loans, yet it allows so much more through yield opportunities. It’s through these tokens that one can use their holdings to take out a loan on a house, or provide the funds on which they can earn passive income.
“We have a thriving dollar-lending business where we actually lend out these dollars backed by crypto collateral,” Monica says. “On the other side, we have corporations that want to deploy a big percentage of their balance sheet to generate yields that are closer to 7% on a yearly basis [rather than] zero, like they have on the traditional market.”
Monica lists Tesla (NASDAQ:TSLA), MicroStrategy (NASDAQ:MSTR) and Square (NYSE:SQ) as institutions leveraging the lending token market for their own gain. While some simply hold their crypto for arbitrage purposes, many companies participate in DeFi-backed loans, lending their holdings to fuel this market and pocket interest.
Decentralized Exchange Tokens
One of the most well-known DeFi applications is the DEX, or decentralized exchange.
DEXs are a popular alternative to the more mainstream centralized exchange, like Binance (CCC:BNB-USD) or Coinbase (NASDAQ:COIN). DEXs offer more privacy by allowing transactions to remain completely anonymous. They are also more secure because of the lack of custody, which keeps bad actors from being able to get your wallet key in the event of a hack.
Anchorage Digital was born as a custodial service and later implemented a centralized trading platform in response to client demand. However, even as a centralized exchange, Monica says the bank wants to allow clients to gain exposure to DEXs. As such, the bank offers custody for a number of DEX tokens, including the Uniswap (CCC:UNI-USD) DEX’s native UNI token. Institutional clients can use this service to build up their holdings and store it securely.
One of the biggest draws to DEXs and their tokens is in staking. Liquidity staking for a DEX might not generate the same high yields as lending tokens. But, they offer a unique reward in the form of governance rights.
Governance allows liquidity providers to farm a yield in the form of voting power. Voting power allows liquidity providers a say on network upgrades and the like, making large governance token holdings highly sought after.
Monica says he admires DEXs because of their rapid innovation. Upgrades like Uniswap’s newest V3 update are coming out at an incredible pace. “They’re making it a lot easier for people to participate as liquidity providers in these networks in a way that doesn’t exist in the traditional world.”
Top DeFi Projects 2021: Insurance Tokens
In the pursuit of a totally decentralized network, we must seek total safety. Luckily, there is an army of developers out there who share this common sentiment and are working to develop top DeFi projects around insurance.
As is the case with any program in development, the DeFi network is full of bugs. In response, a slew of products seek to eliminate bugs and other security risks. By evaluating contracts through audits, or developing new smart contract languages, coders can continue to push the envelope by not only making more powerful networks but also by making safer networks.
CertiK (CCC:CTK-USD) is one of these insurance tokens that’s leading the charge on security audits. The network hosts the most security audits of any auditor. Indeed, the company is behind security checks for many cryptos, including dozens of DeFi tokens; DEXs PancakeSwap (CCC:CAKE-USD) and 1Inch (CCC:1INCH-USD) have both been audited through CertiK.
In fact, this particular DeFi product is so popular, auditors are having trouble keeping up with demand from clients. Even in the crypto slump in the fall of 2020, employees for networks like Quantstamp (CCC:QSP-USD) mentioned overwhelming demand.
“[DeFi is] solving its own problems. If there are issues with security, let’s make better smart contract languages, let’s make it easier to audit these contracts,” Monica says. “It’s happening already. And finally, let’s actually provide the centralized insurance over these contracts.”
Monica’s Anchorage is ahead of the curve on this product; the bank has offered insurance for assets under custody since 2019.
One of the biggest sources of fuel for the DeFi fire has been the commodification of stablecoins. Stablecoins are just what their name implies — coins whose value is pegged to the value of another currency. Typically, these coins have their value pegged to the U.S. dollar; USD Coin (CCC:USDC-USD), Dai (CCC:DAI-USD) and Tether (CCC:USDT-USD) are some of the most popular of these.
Stablecoins are some of the most traded tokens, especially through DEXs. This is because DEXs don’t support the trading of fiat currencies because of their lack of custody. So, tokens trade in pairs with stablecoins. The result is a currency that isn’t technically a fiat but is safe from the rapid price fluctuations that other cryptocurrencies are faced with.
Stablecoins can be staked just like any other token, and they offer one of the safest investment yields of any DeFi crypto on the market. If more volatile DeFi token yields are the Ark Innovation ETF (NYSEARCA:ARKK) of the crypto world, then stablecoin yield funds are the U.S. Treasury notes. They offer lower yields, but they remove the price exposure of the other, more volatile coins. Additionally, one can withdraw their staking any time they want, giving investors more freedom than with a traditional Treasury note.
The issue with stablecoins now is that they must be staked in a centralized exchange (CEX) or DEX to generate yield. However, Monica is quite bullish on their future.
“There will be the rise of stablecoins which generate yield in-protocol,” he says. “Imagine holding dollars which generate yield for your account; not a service that the bank provides, but an intrinsic characteristic of the [currency].”
Think about it — you put money in your wallet, you never put that money in a savings account or into a bond. And when you open up your wallet some days later, you find more money. That’s the future that is envisioned by crypto bulls; a stablecoin that generates yield inside of your wallet, without having to stake it at all.
On the date of publication, Brenden Rearick did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.