DeFi Innovation Dive Part Two: Stablecoins And Asset Management
In our previous article on what makes DeFi an outstanding example of technological innovation, we’ve scratched the surface of two key mechanisms making DEXes possible: automated market makers and liquidity pools. Of course, exchanges are not the only thing that’s required for a financial infrastructure and that makes it tick. Real finance involves multiple institutions, professional tools, and consumer products which together form an ecosystem.
DeFi builders are working hard to provide all crucial components that together would create a stable and sustainable ecosystem. As we know, algorithms are the Web3 answer to institutions and middlemen, but what’s up with the other two: tools and products? Let’s start with the latter.
Turns out, a majority of consumer-faced DeFi products are one way or another derived from the liquidity pools. The pool’s participants provide their funds in various tokens for a fee. This fee is called yield and works just the way s traditional bank deposit does — you provide money to the bank and it pays back with an interest. The cool thing is that while a bank takes its cut (for example, you put $100 on your deposit, the bank then uses it to provide a loan with an interest rate of 10%, yet your deposit has only a 5% rate, the rest is taken by the bank) liquidity pools yields come in full. LP yields incentivize users to participate and come from the fees the DEX takes when the swap is made.
Most DeFi products work the same way: create liquidity, provide collateral, or stake — instead of piling up your funds, make them work. A typical DeFi scheme might include taking a loan with token X as collateral (though there are multiple options with 0 collateral, or using NFTs as one), receiving token Y, staking it, then getting the staking reward, re-stake it while paying back the rest with minimal (or even 0) interest to get your original token X back.
Eventually, keeping track of all the assets you got loaned, staked, collateralized, invested, etc., while remembering to re-stake, re-pay, or withdraw rewards becomes convoluted and cumbersome, so a multitude of portfolio tracing services emerged. Most advanced offer security (such as liquidity pools ratings, which provide pools reputation and potential yield calculators) and automation (for example, re-staking).
While borrowing money in various forms makes economies spin, you’d also want a convenient exchange token that is volatile-proof. Meet Stablecoins — another great invention of the web3 era! Stablecoins are exactly that — they are designed to always have the same value no matter what. Usually, any given stable coin has a price of 1 USD for convenience.
Now, there are several approaches to how a coin could guarantee that its price would always stay at a certain level, so there are multiple Stablecoins. For example, USDC and USDT are both tied to USD, but their emission is controlled by different entities.
Stablecoin utilizes two basic principles:
- token must be backed by some equivalent asset held in reserve (it might be fiat currency, decentralized assets, or even gold)
- its price is calibrated by algorithmically controlling the supply and demand
Stablecoins might be one of the crucial components for widespread crypto adoption. They have all the benefits: easy to transfer, convert, and exchange while being safe for the regular user in terms of preserving the value of the asset.
Want to learn more on DeFi, DEXes, and Web3? Check out the other articles in the series: