Web 3 Brings DeFi Options to the Masses
Cryptocurrency, yield farming, staking, smart contracts, DeFi, Bitcoin as a hedge against inflation. Lately, it’s difficult to avoid these topics. While there may be fear, uncertainty and doubt surrounding the future, it’s important to gain at least a basic understanding of how our industry will change in the next 5-10 years.
How Did We Get Here?
“Web 1” built the foundation of the Internet as we know it today. From the 1980s to the early 2000s, open protocols such as HTTP (Hypertext Transfer Protocol), SMTP (Simple Mail Transfer Protocol), and IP (Internet Protocol) were the foundation for websites. Open protocols enabled developers to innovate quickly and usher in the second era starting in the mid-2000s.
“Web 2” brought an array of new web applications that were built using closed protocols that centralized and consolidated data (think Microsoft, Facebook, Apple and Google). Web applications such as Gmail, Facebook, Yahoo and many others were built during this time period.
“Web 3”, which is still in its infancy, is characterized as decentralized and open. Those are key tenets which will continue to propel it forward. No one company, organization or government has control over this new infrastructure. The first era of Web 3 started in 2009 with Bitcoin, which introduced peer-to-peer transfer of value using a distributed ledger known as the blockchain. Ethereum improved on that in the second era by introducing smart contracts. The third era is defined by ICOs (Initial Coin Offerings) which helped fund many projects that are continuing to innovate in this space. Now DeFi, the fourth era, builds on the previous three iterations.
What is DeFi?
DeFi is short for decentralized finance. It enables anyone with a cryptocurrency wallet to easily participate in a vast array of financial activities ranging from the simple (such as lending, borrowing, and saving) to more complex things (such as insurance underwriting, market making, and synthetic assets). None of this requires a bank or a broker. DeFi leverages the blockchain and smart contracts to enable these types of transactions. Smart contracts cannot be modified by anyone nor can they be blocked once they have been put on the blockchain. They are simply code that executes when certain conditions are met. The beauty of this is that smart contracts do not require trust (the source code is open for anyone to review) and do not require permission to run (that’s the decentralized nature of blockchains).
As this technology progresses, it will lower the barrier of entry to new investors. Estimates, according to The Motley Fool, put the total value currently locked in DeFi at $90 billion. This is up from $25 billion in 2020 and just $8.5 billion in 2019. Between Q3 2020 and Q3 2021, the Ethereum network settled $6.2 trillion in transactions. Visa settled $12.5 trillion in transactions for the 1-year period ending Q2 2021. Although DeFi is still far behind the financial infrastructure as we know it today, it is catching up quickly. If your clients haven’t already invested some money in cryptocurrencies or other DeFi options, they have at least considered it. Advisors need to know enough to continue providing guidance and advice, even if for now it’s simply “be patient and let things mature.”