Ethereum Led the Way, Now Other Projects Are Decentralizing Finance
DeFi protocols have the potential to make finance more accessible and efficient, meaning better rates for the everyday person. Here’s a look at projects laying the foundations of the DeFi movement.
- Bitcoin is one of the most important economic innovations of the last century, separating money from state for the first time.
- Ethereum's success has so far signaled that there is a demand for new kinds of tools for digital money.
- Stablecoins combine the stability of fiat with some of the capabilities of cryptocurrencies, but there are drawbacks.
- New innovations in the stablecoin industry, like Ampleforth, are necessary to bring forward the next wave of blockchain-enabled financial innovation.
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For Bitcoin and Ethereum to be worthy of mass adoption, cryptocurrency as a whole needs to push the boundaries of what money can do.
Bitcoin Lays the Foundation for a Decentralized Future
Bitcoin has changed finance by combining the convenience of email with the scarcity of gold. Some see this as a step toward the complete decentralization of money; others see it as the final solution. Either way, it’s impossible to ignore the impact that Bitcoin has had on cash.
Ever since the cryptocurrency launched in 2009, there have been multiple attempts to build a “better” version of it. Between lesser-known forks like Bitcoin Gold and contentious splits like Bitcoin Cash, no competitor has been able to capture meaningful market share from Bitcoin.
A primitive is the base for building a complex system. In finance, a prime example is PayPal. In the early 2000s, PayPal developed a payment system that allowed users to transfer money over the internet—something unheard of at the time.
PayPal’s success led to an explosion in internet payment companies that ultimately added new functionality and improved the efficiency of transferring value. Today, almost every bank relies on internet banking for a majority of their business.
When the global monetary system moved off the gold standard in 1971, that, too, was a new financial primitive, as commodities backed all successful mediums of exchange.
Attempts at recreating Bitcoin’s core value proposition have been unsuccessful, but using its core tenets to forge something unique is a different story. The success of Ethereum is proof that there is demand for new digital asset primitives, the fundamental building blocks, and tools used by software developers to create new systems.
Most of these new primitives will fail, but a few have the opportunity to change what is possible on the blockchain.
Building Blocks of the Crypto Ecosystem
To understand the importance of crypto innovation, one need not look further than Ethereum. Ethereum took Bitcoin’s mission one step further, allowing people to build applications far beyond just sending and receiving money. These applications are known as smart contracts.
Uniswap operates by allowing users to exchange tokens for one another based on a special equation. An entity does not set the price, but instead, it is implicitly derived from the amount of liquidity available.
The use of a smart contract lets Uniswap work without intermediaries or a central entity that determines the price of each asset.
Compound is a permissionless money market that uses a smart contract. Traditional money markets require a ton of intermediaries and custodians. With smart contracts, this is made possible by creating an open marketplace to match lenders and borrowers directly.
Over a billion dollars was locked in Ethereum’s financial stack earlier this year, via DeFi Pulse.
But the difference between the two goes beyond technology. Token-economics on Ethereum and Bitcoin differ significantly.
Bitcoin’s total issuance is capped at 21 million BTC, and the rate at which new Bitcoins are issued was determined at its inception. These rules cannot easily be altered, even with human intervention.
Ethereum takes a more flexible approach by keeping issuance in the hands of developers and the community. There is no hard cap for ETH, and the amount of Ether issued per block changes regularly. Core Ethereum developers aim to balance adequate security and token inflation.
Proponents argue that this dynamic ensures that security-incentives on the network are long-lived. The downside, however, is that this power could be abused if core Ethereum developers become misaligned with token holders.
Tether (USDT) has the third-largest market capitalization after Ethereum. In sum, stablecoins account for nearly $11 billion, or 4%, of the cryptocurrency industry’s market capitalization.
Size aside, stablecoins are essential crypto primitives. Stablecoins give people access to the stability of the dollar with the flexibility of cryptocurrency.
Stablecoins can be issued by two types of authorities—centralized and decentralized. Most stablecoins, like Tether, are maintained by a centralized issuer. Tokens issued by a corporation like Tether or TrustToken have strong pegs, as they can be redeemed one-for-one for dollars. However, these bank-like corporations are also a single point of failure. Should one of these corporations collapse, then those dollar-backed tokens would become worthless.
A few projects are trying to tackle this problem by restraining the middleman. MakerDAO and Kava are notable examples of protocols that operate on a “de-central” bank approach. Instead of a corporation, software developers are trying to build out more democratic ways to maintain a value peg without relying on a single authority.
Theoretically, by taking out the middleman, these projects would allow builders to limit their legal risk and minimize the chance of an issuer collapsing or going rogue.
In any case, stablecoins have become integral to the health of the crypto-ecosystem. Beyond a mere hedge against crypto-volatility, stablecoins are also becoming a legitimate (and sometimes preferred) way of transferring value.
Stablecoin Innovation Will Unlock Cryptocurrency’s Potential
Improving existing stablecoin primitives is well and good, but it is also necessary to experiment with new building blocks that can push the limits of today’s digital infrastructure. rDAI and Ampleforth are a few examples of projects attempting to push these limits.
Soon, new primitives could allow people to donate to charity without giving up any of their cash. It sounds crazy, but it’s possible.
These donations are achieved by depositing money into a decentralized savings account. The interest from this account is then directed toward a non-profit, like the American Cancer Society. Meanwhile, a donor can withdraw their money at any time without losing their principal.
This is precisely what rDAI does. People deposit DAI into pools for various causes. The DAI is then loaned out on a DeFi money market, which pays interest to each of the causes.
Ampleforth, on the other hand, is trying to create sound money through built-in monetary policy enforced with code. The Ampleforth protocol increases and decreases the number of circulating tokens based on supply and demand. Other stablecoin protocols like MakerDAO replace the middlemen with software developers. Ampleforth wants to take out the middleman entirely.
The market value of a cryptocurrency is determined by taking the price of an asset and multiplying it by the total supply (unlike market capitalization, which takes the circulating supply, which makes the system prone to gaming). For an asset like Bitcoin, total supply is capped while the daily issuance of BTC is fixed.
As a result, supply is not scalable; for the market to grow, the price of BTC needs to rise dramatically, which has been the case so far. Rapid price appreciation poses a problem, however. Bitcoin is too volatile to serve as an effective medium of exchange.
Volatility is bad for a medium of exchange because pricing becomes difficult. If a loaf of bread is $3 one day $5 the next, it’s a burden for consumers.
It’s worth noting, however, that Bitcoin’s volatility is a result of it being actively priced against stable fiat currencies because they have billions (even trillions) of dollars of liquidity.
A common misconception is that AMPL is a stablecoin. It has no peg, and the market determines the price of AMPL. The elasticity in supply, however, allows its price to remain more stable than most cryptocurrencies without being pegged to an external asset. Instead of relying on bankers to set rates, Ampleforth’s code relies on network data.
In a bid to build a better form of money, Ampleforth allows for supply to expand and contract as per market demand for the asset. The price is by no means stable, and neither is supply.
The supply changes tend to shock most first-time readers, but it’s done in an algorithmic and decentralized fashion. Changes in supply do not dilute token holders—instead, holders own a predetermined percentage of the network based on their tokens. When supply changes, tokens are automatically credited or debited to one’s AMPL address.
Crypto primitives like Ampleforth and rDAI can push the boundaries of what is possible using digital assets. Innovators will iterate through many different ideas before finding the primitives that will benefit the masses.
By taking out the middlemen, it is possible to reduce the friction and expand the capabilities of digital money.
This article was sponsored and commissioned by Ampleforth, Crypto Briefing’s partner in DeFi.