Bitcoin was launched over twelve years ago and has since experienced unprecedented growth as a store of value. The world’s first practical decentralized cryptocurrency is a modern-day marvel of software engineering, cryptography, and trustless economic incentivization, often lauded as one of the greatest inventions of the 21st century — but this wasn’t always the case.
Today, Bitcoin is a household name, and everyone wants to get their hand on it. However, during the early days, most financial advisors and market analysts dismissed the digital asset ecosystem as a glorified Ponzi scheme – a bubble eager to burst. The ICO scams of the years that followed did little to improve their confidence, but those who persevered through the fear, uncertainty, and doubt are certainly glad they held on.
The cryptocurrency space is not one for the weak-willed. Though exponential gains are always appreciated, volatility works both ways, and abrupt market movements can cripple entire portfolios if managed incorrectly. Over the years, “HODL!” has evolved into a battle cry for blockchain proponents, encouraging investors to endure the anxiety-inducing drops and buy the dip.
Accumulating Bitcoin was the dominant strategy for wealth generation in cryptocurrency markets, and while this is still largely the case, the rise of decentralized finance has somewhat flipped the script. Ethereum introduced the world to programmable smart contracts, enabling developers to deploy code on the blockchain to manage financial applications, and this has created a whole new world of use-cases for the technology and its associated tokens.
From staking protocols to yield farming strategies, decentralized finance (DeFi) is causing a paradigm shift in the way crypto-assets can produce value. Bitcoin was designed to be a global peer-to-peer decentralized payments network, but how valuable is an asset that no one spends? HODLing and dollar-cost averaging may have been a practical approach to generating wealth before DeFi, but with the sheer number of ways investors can put their assets to work today, dormant assets prevent investors from generating more profits from their investments.
When it comes to generating value from dormant assets, there are hundreds of platforms out there in both centralized and decentralized forms. Centralized platforms offering interest on cryptocurrency deposits are often referred to as ‘crypto banks’ since they function similar to how the traditional banking system operates. When an investor deposits digital assets into a centralized interest account, the platform takes custody of the assets and offers a variable or fixed interest rate, usually compounded monthly.
To provide this interest, some platforms also allow users to borrow assets at higher rates than they are lent out for, while others use the deposited assets to enter various positions in spot and derivatives markets to produce gains. The interest rate varies based on how well the platform’s investment portfolio performs, and any losses are borne by the centralized entity.
Decentralized finance protocols operate in a slightly different way. Instead of trusting a third party to take custody of the assets to generate interest, investors lock tokens into a smart contract that manages a pool of assets lent out to borrowers as overcollateralized loans. This means borrowers are required to deposit assets worth more than the tokens they’re borrowing to ensure lenders don’t incur losses from borrowers running away with the funds, or if the value of assets in collateral drops below the loaned amount.
HODLing in the hopes of appreciation works when the investment’s primary function is a store of value, but in today’s burgeoning cryptocurrency lending economy, it’s in every investor’s best interest to put their assets to good use. Unfortunately, not every token has dedicated, liquid lending pools for others to borrow from, and how to make the best use of these digital assets is a question that doesn’t have a simple answer.
Dominating the Dormant
Over five thousand cryptocurrencies exist, but only a fraction of them are worth investing in beyond the goal of speculative short-term profits. In DeFi, lending only works if someone wants to borrow, and without a proper fundamental cause for a token’s existence, neither centralized nor decentralized protocols will be able to make use of them.
If there are no means to lend or borrow the asset, unless there are reasons to hold on to the tokens, it’s probably best to swap them out for something that has more utility. DeFi loans are overcollateralized based on a loan-to-value ratio (LTV), and this metric is determined by the quality of collateral supplied to the protocol. Borrowed assets have lower LTV ratios for higher quality collateral, and swapping the dormant tokens into these assets makes it much easier to generate wealth over time.
The real problem occurs when the assets in question are so illiquid that they cannot be swapped for other tokens. Sadly, this is usually the case with fundamentally bad investments made based on speculative interest that has long since died out. As rough as it sounds, in these cases, it’s probably best to move on to better investments than to cry over spilled milk.
With so many options out there, it’s not always clear which projects are worth investing in to produce value and which ones are merely out to take your money. The DeFi space is growing faster than investors can keep up, with the total value of assets locked into DeFi platforms rising from under $700 million last year to nearly $70 billion today. Investing in cryptocurrencies is risky, and the DeFi space is even riskier, especially for newer investors who can’t discern quality from scams.
Projects like Bonded.Finance are certainly helping with this problem, enabling investors to hold a single token to profit from a diverse portfolio of DeFi tokens which is automatically rebalanced by a machine learning algorithm. Having identified close to $50 billion of untapped liquidity in the DeFi space, the platform aims to build a network of value by placing the sector’s broad performance under a single banner.
This is useful for less experienced investors to get a feel for the space and understand what the markets value and what they abhor. Since it is automatically adjusted by the protocol’s algorithm, Bonded.Finance also removes the need for traders to constantly keep track of the various assets in their portfolio and can be immensely beneficial to long-term investors looking to generate gains from the flourishing decentralized finance sector.
As blockchain technology improves, the industry is poised to take advantage of new and innovative ways to generate value from cryptocurrencies. DeFi isn’t just an alternative to the centralized financial services sector, but rather a peek into how our monetary systems will evolve in the future. It’s been twelve years since Bitcoin was introduced to the world. However, the space is still centuries younger than the established system, and with how much wealth will eventually be transferred over, the rapid progress seen over the last year is but a fraction of the industry’s growth potential.