Learn about DeFi’s billion-dollar opportunity in 10 minutes

In recent years, decentralized finance (DeFi) has radically changed the way we use financial instruments. Unlike the traditional financial system, DeFi works according to a protocol that runs on a decentralized infrastructure powered by blockchain technology.

In this episode of Startup How Tos, Julian Hosp, co-founder and CEO of Cake DeFi, discusses the vision and scope of decentralized finance, the opportunities and challenges in building great DeFi companies in Asia, the key players and gaps in the market, and where the sector is heading next.

Time codes: 

00:06 – Creating value

02:32 – Decentralized lending

04:46 – Decentralized exchanges

06:22 – Decentralized tokenization

08:42 – Decentralized prediction market

Experience the full workshop here.

Transcript: 

Creating value

The very first one is that of creating value a.k.a. creating coins, creating a blockchain decentrally. And so, the question that most people always ask is: What coin should I be investing in? Which coin has the most upside? And obviously, it’s very easy to invest in anything because anything goes up. It doesn’t really matter what goes up. But so, I actually think in this next cycle, we’re really going to see very fundamental questions, whenever it comes to actual value is: What is the actual utility of a coin? I want to be very frank. Most people are not honest about this. Most people call Bitcoin a cryptocurrency, but it’s actually not true. There’s not a single thing in this world that’s meaningful that actually gets priced in Bitcoin. I’m not saying that you cannot pay with Bitcoin, but it’s actually – whatever you’re paying for, it’s not priced in Bitcoin, it’s priced in dollars or euros or whatever, and it gets converted into Bitcoin at the price of sale. But it’s not priced; it’s not measured in Bitcoin. And as a medium of exchange, if you don’t have the other two, it’s – the question really becomes: What is the actual utility? So I always believe, for example, Bitcoin doesn’t actually function as a currency. It’s an insurance policy. It’s a credit default swap on the entire centralized system. This is important to understand because it kind of shows value going up, value going down. And one fundamental question that I think is going to become more and more important, especially when we start hitting this early-adopter stage – and I’ll go more into the late-adopter stage – is a very famous angel investor question always, which is: Whatever you’re building, whatever you have, can this be used by an eight[-year-old], and by an 80-year-old? And that is a major hurdle, in my opinion, in the entire DeFi space as a whole, because it’s so difficult to actually use those things. And so, at the end, this is the main question, in my opinion, of the coins that are going to be doing well. And you’ll be surprised. There’s not that many blockchains who are actually doing this. And it’s going to be, quite, separating some of those platforms going forward, where many will just not make it and a few will actually make it. I really hope you as an investor get a bit of a mind change in asking yourself those questions when you invest into a coin. Are you actually going to use that coin? Can you actually use it yourself? Can you envision someone that’s eight or 80-years-old to actually use that? If not, the odds of this protocol or the odds of this platform not getting super large, and rather [only] being a niche is very, very high. 

Decentralized lending

The next part has been in the news massively, with Three Arrows Capital, with Celsius, with Hodlnaut here, and it’s this entire idea of lending. So, you as an investor go on a platform and you lend out funds. The big issue on this is that most platforms out there were not transparent about how these funds flowed. But – and now this gets very, very interesting – and I want to bring one topic up that right now in the news doesn’t get discussed much. If you look at Three Arrows for example, Three Arrows, they borrowed and lent out billions of dollars, and none of the outstanding loans, literally none, got paid back. The banks didn’t get their money back. Customers didn’t get their money back. Investors didn’t get their money back. But you know who got their money back? The smart contracts [which] Three Arrows interacted with. And that’s really, really fundamental and powerful, because that means that a smart contract – so a lending contract on a blockchain – is enforced stricter than the actual physical law that we have. And the reason for that is because in a smart contract, there is no “just give me something back, but I give you nothing in return.” This exchange is forced and I actually believe a lot of platforms will start to understand this. They will start understanding that lending via DeFi is something that’s very, very powerful. But in most cases, the protocols are now really well tested, and it’s going to be a very interesting model going forward in how money is being borrowed and how it is being lent. So, if you are someone who looks for getting cash flow on Bitcoin or ETH or whatever or stablecoins, then one thing I can really just highly recommend is [to] understand how are your assets being lent out? How is the yield being generated? Because if you sit here and you think “Oh, that’s it, this entire DeFi lending is done, that’s the end of it.” I think it’s exactly the opposite. I think it just weeded out all these protocols and all these concepts that don’t work. And over the next years, we’re actually going to see a massive spike in what’s left over, and in this case, what is actually working. 

Decentralized exchanges

One topic that was extremely driving that entire craze and this entire, kind of, hype around DeFi is that of decentralized exchanges. When you don’t have Binance, for example, or Coinbase facilitating a transaction, but it’s actually the blockchain itself, you have a major downside of this concept being relatively slow because you have to update the entire community about the exchange. However, on the other side, you don’t have this trust issue. Plus – and now comes a very important part, and DBS is actually dipping into this already – you can pool liquidity together. And this is one of the most important drivers to the entire space. If you were to open an exchange today yourself, obviously you have a chicken and egg problem. You need customers, but customers would only come to you if you also have liquidity, because why would customers come to you if you don’t have liquidity? But you’re only going to get liquidity if you have customers. Chicken and egg. And that is why liquidity always tends to centralize, always. Because there’s an incentive to be where others are to have a stronger marketplace. That’s the power of what Binance or Coinbase – it’s what makes them so strong. Now, one thing that’s going to disrupt them – and it’s going to disrupt them massively – is when liquidity actually moves away from centralized finance (CeFi) and it moves onto the decentralized exchanges. And then the CeFi players, centralized finance players, they are going to run their own order book, but they’re going to settle in regular intervals with this DeFi pool. And that’s going to be a very, very powerful concept that I think, over the next cycle, the next couple of years, is going to actually drive a lot of demand and a lot of very innovative players in the space who understand this. So, it’s not so much the B2C anymore. It’s going to go into the B2B, and I think that’s going to be quite exciting. 

Decentralized tokenization

Decentralized stablecoins, algorithmic stablecoins. It was this incredible picture of a coin having a US$50 billion market cap and completely going down to US$0, getting completely wiped out. And this is – this was not something that was not foreseeable, actually the exact opposite. Most players – also, the reason we at Cake DeFi never listed Terra LUNA or UST, a stablecoin, was because of that fear: What would happen if the algorithmic part actually fails? We got a lot of pressure from our customers to list it, and until the very end we managed to refuse that, even though a lot of customers were threatening to leave. Trust me, as a CEO, this can be sometimes very difficult. Now, does this mean that [for] hybrid stablecoins, algo stablecoins, decentralized tokenization, that’s the end of it? Not necessarily, I think the exact opposite. I think we as a community now need to figure out how to actually do this. What are the ways – how the algorithmic part can actually be done? There’s always a massive upside in decentralizing certain processes. In this case, if you have tokenization, for example, the biggest stablecoins, the three biggest stablecoins we have right now is that of Tether, is USTC. Those three function perfectly. The big issue is [that] we have to trust Circle, we have to trust Tether, and we have to trust Binance. And all three of them actually follow US regulation. Now, I’m not saying there’s something bad with this. I’m just saying: What happens if the US actually goes and says: “who actually decides on the Ethereum merge, if the merge is going to be successful or not?” And most people didn’t know what to answer. Of course, there’s a technical aspect to that. But if you then think it further, who actually decided were the stablecoin providers, because it was three stablecoin providers that said which fork are they going to pick. Are they going to stay on the proof of work fork, or are they going to stay on the proof of stake fork? And if they would have stayed on the proof of work fork, the proof of stake fork – which was the innovative new world – would have crashed to zero because there would be no stablecoins on there. No Stablecoins means no NFTs, [which] means no DeFi. It means nothing that functions. So, these dependencies can be very powerful in a good and in a bad way. So, there is a massive, massive, massive market for decentralizing this aspect. I think we need the innovation, especially in the space – in the entire DeFi space. 

Decentralized prediction market

One thing that I really feel is going to be the future, and hasn’t been tapped at all, are those of decentralized prediction markets. Because now we’re going into – if you actually think this through – in having an entire decentralized financial ecosystem. And the last thing that’s missing are options, futures, derivatives, and now you’re basically copying the entirety of Wall Street – if you want to call it [that] – or the entire economy. And you’re building a decentralized digital economy with all its functionalities. As an investor, also for us as a platform, a lot of this, especially in its early iterations, really have to be seen as startups that are probably going to fail. So, you have to understand this, that the risk-reward ratio is very much skewed to the risk side here. But there will be projects who will succeed, who will get options and futures, who will get this done. But that is what makes this super exciting because suddenly, you don’t have decentralized market makers anymore, you don’t have centralized dependencies anymore. Everything becomes decentralized and this can be extremely empowering for [the] financial inclusion perspective, for possibilities – arbitraging, obviously – but also just accessibility.