Crypto is growing at an unprecedented rate. This year it reached a market value of $2 trillion. Decentralized finance (DeFi) has grown into one of the most prominent ecosystems in the digital currency space.
Currently, DeFi has a total value locked (TVL) of $142 billion. Lots of projects in DeFi have amassed billions of dollars with the ability to lend, stake, and borrow cryptocurrencies. As more users are drawn into DeFi, we see incredible exponential growth.
There is seemingly such an abundance of capital in DeFi right now. However, it seems to remain unquestioned where this value actually comes from.
We take the value of various tokens, coins, and the value accrued by a project for granted. But this needs to be questioned, or else can we truly claim to understand the space?
It’s common knowledge that banks make the majority of their profits on interest. So, if there isn’t an understanding of where the yield comes from in DeFi, then clearly, more education is needed for those both in and out of the cryptocurrency space.
DeFi yield creates farms
Yield farming is a feature of DeFi that has garnered popularity. It is currently the most significant growth driver for the space.
The premise of yield farming is that a crypto holder can lend their digital assets out as a loan to another user. This is done by the holder of the asset staking their crypto into a lending pool. From there, the borrower can access funds as a loan payment and pay interest on the crypto loan.
The interest that the borrower pays on the crypto loan accumulates as yield. This is then paid to the lender as a reward for staking. One of the biggest advantages of yield farming that some users may be unaware of is that you can earn consistent yield regardless of the state of the market.
Beyond earning yield on a lending protocol through yield farming, the word “farming” in crypto means much more.
Farming encompasses farming liquidity pools (LPs), like Raydium LPs or SushiSwap LPs. It also includes utilizing protocols like Harvest Finance or Muse, where you can stake your NFTs.
These farming mechanisms reward users in crypto, incentivizing them to contribute more to the platform and help grow the ecosystem.
This symbiotic relationship between protocol and user, where both parties earn and benefit, whether through lending or staking, continuously generates yield as more people flock to DeFi and deposit their assets.
Airdrops and how they create value in DeFi
One of the other ways the DeFi space has accumulated such a colossal TVL figure is through airdrops. These have become something of commonplace among crypto communities.
It involves projects releasing limited amounts of their tokens as a free giveaway to a select few individuals who sign up for the release on time.
Airdrops are a distribution of crypto tokens or coins for free into users’ wallet addresses and are used primarily to draw attention to a new project.
In addition, they can also be used as a way to generate clout, especially if there’s something big that the project is announcing or if they are looking to promote something.
Airdrops are a good way of monetizing interest tied to a project and are a tactical customer acquisition technique. While there may be significant tangible differences, it’s really very similar in concept to paying for advertising space such as a billboard, and both have an identical objective. They aim to draw more people to their product or service.
Airdrops are a tactic to create and distribute wealth to a project, and the hype behind them is enough to generate the desire to claim a token, which therefore drives the value up.
Value beyond a single DeFi project
If the airdrop comes from a project with a solid platform, tokens can fetch high prices. This creates an influx of value to the DeFi space.
Depending on the number of tokens released in the airdrop, the price can also be influenced if the tokens are later sold. So airdrops are beneficial to the project releasing the tokens and help keep the flow of capital into DeFi healthy.
Airdrops are also a customer acquisition cost for a project. With traditional internet ads like Google or Facebook, only a small percentage of people will click on your content, which may be less than 1%.
However, with an airdrop, close to 100% of the people will likely interact with your platform after receiving a token. Thus, leading to more users and ultimately more value in the project.
Revenue generating protocols – AMMs an example
Another way that DeFi has accumulated value is through revenue-generating protocols such as SushiSwap. They charge fees for users to swap their currencies before the fees are then recycled back into DeFi.
While high fees are often a deterrent for users, there is still enough demand for these protocols in the space to keep capital flowing into these projects.
One of the key examples of revenue-generating protocols in DeFi is automated market makers (AMMs).
AMMs are an underlying protocol that powers decentralized exchange. AMMs are autonomous trading mechanisms that eliminate the need for centralized exchanges and related market-making techniques. Popular AMMs are Uniswap, Balancer, and Curve.
AMMs come in different forms. An AMM like Step Finance is permissionless and allows projects to set up their own pools without the need to apply or go through any approval process.
Such AMM’s put your token in front of a global audience. It creates an opportunity for people to earn on your token – adding to the TVL of your project. As such, it incentivizes more people to hold and invest in the asset. This is why AMMs have become a popular promotional tool in DeFi.
DeFi needs to have value
For yield to be retained and accumulated in DeFi, every project needs to create something of value.
Also, every token launch should have tokenomics that build value into the token itself. In a space that is becoming more saturated with meme coins, this is becoming more crucial than ever.
In the traditional financial system, most companies have a more narrow window for generating revenue for their businesses.
For example, Apple can sell an iPhone for $1,000, but that one-time payment is the most value they can extract from their product. In DeFi, you are reusing money (crypto), then borrowing against it to create more and earn in a big way.
Capital efficiency, the ratio of how much a company is spending on growing revenue and how much they’re getting in return, is at the heart of DeFi earning mechanisms.
DeFi lets you earn a yield on your same dollar (crypto) multiple times, stacking yield on top of yield. Bypassing third parties and traditional bank fees is just the icing on top of this lucrative business model.
As crypto further journeys down the straightening path towards mainstream adoption, DeFi protocols will find their place in contemporary society. We could see examples of their use in daily scenarios.
However, the crucial thing here is understanding exactly where this money has come from and how this is helping to build the DeFi ecosystem into a genuine alternative for mainstream finance.