You don’t have to be a fully-fledged decentralized finance (DeFi) startup like AshSwap or Curve Finance to enjoy the benefits of DeFi. Financial integration to the blockchain helps strengthen a company’s technology stack while raising capital. Incorporating elements of DeFi as a financial layer opens your business up to more transparency, decentralization, and security. Startups looking to incorporate DeFi and meet the future of finance head-on need to equip themselves with the best protocols and regulatory procedures now, all while better understanding how to navigate the risks and rewards to create something successful.
DeFi-ning the benefits
DeFi stands out as an alternative to traditional finance (TradFi) because it sidesteps today’s financial bureaucracy, heavy-handed restrictions, and centralized regulators that control financial applications and slow down transactions. Unlike TradFi, where startups put their trust in intermediaries like banks or stock exchanges, all financial services run on a decentralized blockchain.
DeFi’s real trump card is that users maintain full control of their funds at all times. The lack of barriers to entry also means the financial market is open to anyone with an Internet-enabled device and a crypto wallet. Since DeFi eliminates a range of costs for users – such as direct, privacy, censorship, and networking – you’re free to direct these funds elsewhere, like optimizing your protocols and risk management tools.
Blockchain solutions also enable investors to track and verify a company’s financial performance far more easily than with centralized financial institutions. But all this means very little if your project lacks utility. Respond to a current problem with a product or service that has a tangible purpose, and continually upgrade the initial version. For your DeFi startup to have a working product, participants should be using it on a regular basis.
Ditching traditional contracts
Digitized smart contracts take the place of traditional, paper-based contracts that rely on expensive intermediaries. The terms of these contracts are written directly in computer code by different parties and stored on the blockchain. This code will automatically perform certain actions when the specified parameters are met. Before signing a smart contract, you should verify its ownership and ensure that the contract is upgradeable. Check if the implementation matches the business requirements. Ensure each step is executed in proper order and in a timely manner. Make sure to verify that the smart contract was audited by a third party.
Smart contracts are particularly useful for making payments, transferring, or exchanging funds between two or more parties. And you can customize and design them for different use cases like creating voting systems, crypto wallets, tokenized assets, or supply chain management. Reach out to specialized code auditing firms that can carefully anticipate and define the costs of interacting with each smart contract, also known as gas fees. These firms can ensure the contract has clear limitations that cannot be exceeded.
Finding external support
It can be a challenge for founders to incorporate the advantages of DeFi, and avoid product and business pitfalls like lackluster token utility or inequitable distribution. In addition to strong legal advice and a blockchain-savvy tech team, you need external consultation. Partner with DeFi launchpads that offer the possibility for incubation, help optimize your business plan and grow your communities organically. Bring on experts to audit your business and suss out system vulnerabilities.
For economic security and general business management, a protocol must ensure that a startup has the right economic model to sustain the product’s business and avoid liquidity issues that can drain user funds. Approach financial advisors that can attest to the soundness of the economic models and assumptions before going live. Organize testing sessions with the community to prove that the model works in practice. In order to safeguard against exploits and technological threats, create bug bounties.
Understanding DeFi protocols
DeFi protocols are essential to the inclusion of companies in nations with limited access to the global banking apparatus since they offer transparency for both stakeholders and users on how the funds are used. In contrast to TradFi, DeFi protocols give investors additional security and transparency to verify the status of their assets. While centralized institutions move investors’ money to suit their needs, DeFi protocols allow users to monitor their investments on a public blockchain ledger.
An example of these protocols is Uniswap, a decentralized cryptocurrency exchange for traders and liquidity providers. Uniswap facilitates automated transactions between cryptocurrency tokens on the Ethereum blockchain through the use of smart contracts. There are insurance platforms like Nexus Mutual for Ethereum users who want to share in smart contract risks, participate in the governance process and earn rewards while doing so. Also on this list: peer-to-peer platform MakerDAO, which creates a bridge between crypto and fiat currency by pegging the DAI token to the US dollar. When pegged to a more stable currency, users can transfer money cheaply, trade or save assets, and earn interest. Until recently, they felt reassured that the value of their tokens wouldn’t crash. However, the U.S. Treasury Department’s decision to sanction Tornado Cash, which allowed crypto users to conduct transactions anonymously, is now threatening the decentralized nature of MakerDAO’s DAI stablecoin while the platform scrambles to decrease exposure to the centralized token.
Measuring risk within DeFi
DeFi projects don’t rely on intermediaries, so the same risk management strategies don’t apply. Smart contracts present new forms of risk, such as attackers stealing funds by exploiting bugs in vulnerable code. The first step is to identify and assign different risk levels at the deployed smart contract level.
Impermanent loss may be the biggest risk for liquidity providers and refers to the difference between holding crypto assets – the HODL strategy – and locking them in a liquidity pool. This only occurs when the performance of one token deviates from the other, and once you withdraw your liquidity from the pool, this loss becomes permanent. The greater the deviation, the greater the loss. It can be profitable to provide liquidity when there’s a lot of trading in the pool, even if the pool is at risk of impermanent loss. This depends on the protocol, the specific pool, the assets deposited, and the general market conditions.
There are always risks when it comes to gas fees, tokens, governance, and even regulatory and exogenous risks. But just like risk management models built a solid foundation for modern financial markets, DeFi requires startups to reimagine these models and implement them throughout their protocols and as part of decentralized applications (dApps).
Choosing multiple use cases
DeFi has the ability to outperform aging TradFi models and systems, particularly as DeFi initiatives and application cases rise. Peer-to-peer borrowing and lending, decentralized exchanges, and insurance to decentralized autonomous organizations (DAOs) are only growing in this context. For any crypto startup wanting to incorporate DeFi, nailing down your use cases is essential – and just one isn’t enough. If you want to focus on governance, trading, swapping, or derivatives, that’s all great, but think bigger, too. Find ways to build on the legacy DeFi system. Use your DeFi use cases to develop the risk management models and optimization the industry needs. This is the answer to creating stability during volatility. That’s how you attain unicorn status.
