Bitcoin 2019 — Year of DeFi

2019 was the year of DeFi (Decentralized Finance) for the Bitcoin ecosystem.

According to LoanScan, there are currently 7 platforms that offer interest on Bitcoin deposits and 5 of the 7 platforms only started publicly offering these services in 2019.

So what led to the explosion of the DeFi space?

Bear Market 2018 — Heavy Short

In 2018, Bitcoin fell by 85% from 20,000 to 3,000 and, there are only 3 major spot exchanges that allow you to short its demise. These are Kraken, Bitfinex, and Poloniex, i.e. the ones that support margin trading. While Kraken adopted a fixed funding (borrow) rate of 0.01% every 4 hours (22% annualized), Bitfinex and Poloniex adopted a dynamic funding rate that allows its users to lend out to other users. With dynamic funding rate, if the demand was high, the interest rate would go up and if the demand is low, the interest rate would stay low.

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Low Liquidity on Margin Exchanges

Although there are these exchanges that allow margin trading, these exchanges don’t always have the best liquidity. Binance and Coinbase, for instance, have a deeper order book when compared to the likes of Kraken but there is no way for you “sell” (short) Bitcoin without actually having the coins first.

The problem is also exacerbated by the lack of liquidity on a single exchange. If you were to purchase $1 million USD worth of Bitcoin on Coinbase, you would get a price slippage of 0.3% off the current mid-price (A loss of $3,000 on a single transaction).

Hence, even if the likes of Coinbase do allow margin trading, it would be unlikely for institutional traders (Whales) to book a large trade through Coinbase alone. The trader would most likely want to split up the trade (into chunks) and unload them onto a few exchanges simultaneously in order to obtain the better price.

Fiat Friction

Exchanges that have the most 24 trade volumes don’t always allow users to deposit Fiat (USD, SGD etc).

Only 2 of the top 5 exchanges (Bitfinex and Kraken) offer Fiat deposits and these exchanges charge up to 1% as single processing fee on top of the SWIFT fee that is charged by the banks.

Borrowing and Lending for Institutional Traders

These three factors have contributed significantly to an increase in demand to borrow Bitcoin amongst institutional traders. These traders typically represent Hedge Funds that denominate their holdings and performance in fiat (USD, etc). In order to trade the Bitcoin market, these institutions would provide (post) USD or USD stablecoins with platforms like Hodlnaut as collateral in return for borrowing Bitcoins.

In an event where the institution goes bust, Hodlnaut will use the collateral to purchase the Bitcoins that were lent out to repay its users.

Upon borrowing the Bitcoins, the institution will now be able to fund their accounts on crypto-only exchanges such as Binance and Huobi to perform their trades.

Conclusion

The DeFi movement serves as a bedrock for the development of the Bitcoin market and paves the way for more institutional investors to enter the space in 2020.

Happy New Year — From the Hodlnaut Team