The financial landscape is evolving with decentralized finance (DeFi).

DeFi operates without intermediaries and provides accessible, transparent, and user-controlled financial services through decentralized applications. In contrast, CeFi (centralized finance) involves traditional financial services managed by centralized entities (banks), which provide regulatory security and user-friendly experiences.

DeFi stands for “Decentralized Finance,” which means that there is no central party facilitating or controlling financial transactions. It is almost entirely based on Peer-to-Peer.
Beginners in DeFi can expect a learning curve and rapid innovation. The current centralized financial landscape is showing significant mainstream adoption and institutional interest in DeFi, with a promising future characterized by increased adoption, improved interoperability, enhanced security, and clearer regulations.

In essence, digital assets and their enabling protocols are transforming the financial world with groundbreaking and sustainable possibilities.

What are digital assets?

Digital assets are electronic representations of value or rights, or mediums of exchange that are traded on the blockchain, including the well-known cryptocurrencies such as Bitcoin and Ethereum, which use blockchain technology to enable secure and transparent transactions.
Blockchain protocols such as Bitcoin and Ethereum provide the foundation for creating and managing these assets, with Ethereum enabling more complex applications through smart contracts. The protocols that facilitate digital assets are therefore fundamental to how digital assets work. They set the rules for how these assets are created, transferred, and managed.

Here is a quick overview of the most common types of digital assets in use today:

Cryptocurrencies : These are what most people think of when they think of digital assets, and the two most popular are Bitcoin and Ethereum.
Security Tokens : These are tokenized versions of securities (e.g. stocks or bonds) that are then traded on the blockchain. 3. Stablecoins: These are tokens that are directly tied to a fiat currency (e.g. the US dollar). The most popular Stablecoins are USDT and USDC.
NFTs (non-fungible tokens): These are tokens that represent the digital ownership of a tangible asset, including real world assets such as a Picasso painting or real estate. These can also be digital assets such as tweets or JPEG files. These are tokens that cannot be exchanged for a similar token (e.g. any Bitcoin can be exchanged for any other Bitcoin, but NFTs cannot be exchanged for each other 1-to-1).

What are digital asset protocols?

Let’s say that if the cryptocurrency or digital asset token is a train, then the blockchain protocol is the track it runs on. In other words, the blockchain protocol is the technological and cryptographic foundation for how digital assets are constructed and transactions are recorded.

The two most popular blockchain protocols within the digital asset industry today are Bitcoin and Ethereum. There are other blockchain protocols that are gaining popularity, such as Solana or Cardano, but each protocol offers a different kind of value proposition to entice decentralized application developers to use it (e.g. faster processing times, more transactions per second, lower transaction fees, or lower energy consumption).

It should be noted that different blockchains are not compatible with each other. For example, tokens built on the Ethereum blockchain cannot be transferred and traded with tokens built on the Solana blockchain, and the same goes for other blockchains.

Developers of decentralized applications (DApps) will create something called a smart contract, which is a contract made up of programming code that is executed in an automated manner. A very simple example is building a lending application on the Ethereum Blockchain, where digital assets are lent to a borrower, and on the last day of each month, the borrower’s payment is automatically made to a lender, and if not, the collateral is automatically seized.

This sounds similar to how borrowing from a traditional bank works, but a key difference is that the process on the blockchain is fully automated and done without any intermediaries or third parties.

What are the Crypto Capital Markets?

The digital asset ecosystem differs from traditional financial markets because everything and everyone is decentralized. Below is a logical list of the main segments of the crypto capital markets and a brief description of each segment.

A) Fundamental Ledger Layer

This is where transactions are recorded, and it includes three fundamental components namely:
Blockchain Protocols: These are the technological infrastructures used to log transactions (e.g. Bitcoin, Ethereum, Solana or Cardano)
Blockchain Tokens (cryptocurrencies): These are the tokens used as a medium of exchange for transactions on the blockchain protocols (e.g. BTC, ETH, XLM or BNB).
Miners and Validators: Institutions or people who mine the transactions, verify them and create new blocks on the blockchain. (e.g. Bitfury, Giga Watt, Genesis Mining or F2pool)

B) Execution Layer

These are venues and institutions that facilitate transactions and provide liquidity to the market, such as;
Exchanges: Marketplaces that facilitate the trading (buying and selling) of digital assets. (e.g. Mercury iconex, Binance, Kraken or Coinbase)
Lending Agencies: Institutions that provide loans to market participants with digital assets as collateral. (e.g. BlockFi, Celsius, Salt or Nexo)
Liquidity Providers / Market Makers: Institutions that provide liquidity to markets to facilitate trading. (e.g. Galaxy Digital, Amber, Genesis, or Bluefire)

C) End User Layer

These are the end users who transact in and with digital assets. These are both private customers and institutions, such as hedge funds, banks, family offices and asset managers. (e.g. Blackrock, Grayscale, VanEck or MicroStrategy)

D) Decentralized Finance ("DeFi") Layer

These are the decentralized applications or applications that are built on top of blockchain protocols. There are two main components to the DeFi layer namely:
DeFi Protocols: Similar to blockchain protocols in that they act as the "node" for interacting with different aspects of DeFi. (e.g. AAVE, Compound, UniSwap or MakerDAO)
DeFi Tokens: Tokens of DeFi protocols that enable management and governance of the protocol. (e.g. AAVE, COMP, UNI or MKR)

E) Service Layer

These are institutional players that provide professional services to the digital ecosystem. These include:

Compliance: Compliance with blockchain anti-money laundering / Know Your Transaction (KYT) and Know Your Client (KYC) laws. (e.g. Chainalysis or Elliptic)
Custodians: Institutions that hold your private keys (these can be dedicated custodians or exchanges). (e.g. BNY Mellon, Mercury Iconex or Coinbase)
Administrative and Tax Service Providers: Companies that provide administrative and tax services for crypto funds. (e.g. TAXbit)
Transfer and Clearing Infrastructure: Companies that help facilitate the transfer and settlement of digital asset transactions. (e.g. FireBlocks)
FIAT on and off-ramp: Banks or financial institutions that facilitate the exchange of FIAT currencies for digital assets. (e.g. Silvergate or Signature Bank)

CeFi transactions versus DeFi transactions; two worlds apart!

Transactions are executed differently within the digital asset industry (DeFi) than in traditional financial markets (ceFi). To illustrate this, we will highlight the economic principle between CeFi and Defi below for the financial topics investing, transactions and borrowing.

Transactions & investments within CeFi:

An investor wants to buy 100 Microsoft shares (MSFT). This person enters his order on the portal of his choice. The order is then forwarded to a trading desk and then forwarded to a financial exchange, where the buyer is matched with an order from a seller. The buyer and seller receive a confirmation that the transaction has been executed and the "Clearinghouse" receives the order data. The "Clearinghouse" then sends settlement instructions to the respective custodian banks and the transaction is finally settled. This process usually takes 2 days. All these steps are related to ensuring the security and reliability, and mitigating manipulation and fraud within the traditional financial markets. The result is therefore long time and high costs for both the buyer and seller.

Transactions & Investments within DeFi:

A trader wants to buy 1 BTC. He can register and log in directly to a financial exchange such as Mercury Iconex, and place his buy order. The order is matched with an online seller and executed. The transaction is then added to the blockchain and the settlement and confirmation is completed. This process usually takes 2 to 10 minutes depending on the liquidity. In a blockchain-based transaction, the timelines for Release and Settlement are greatly reduced due to the absence of third parties, due to the Peer-to-Peer nature of how blockchain networks work and how transactions are stored on the blockchain itself.

Lending within CeFi:

In traditional financial markets, customers put money into a savings or checking account and that earns money. The bank takes that money and lends it to private or business customers at a higher rate of return and keeps the difference (traditional spread lending).

Borrowing within DeFi:

In a DeFi scenario, a customer does not give their money to a bank, but rather pledges their digital assets (Bitcoin, Ethereum, etc.) in a fund (e.g. smart contract) that every borrower has access to and they get paid the interest automatically in the token that is pledged (e.g. if Bitcoin is pledged, interest is earned in Bitcoin). This is all done in Peer-to-Peer format and is relatively frictionless because it is all done via digital smart contracts and the rates are set based on supply and demand. This way, institutions or individuals have full control over their funds at all times.



Currently, DeFi liquidity pools are mostly permissionless. This means that anyone, including individuals or institutions, can access these funds and participate as a lender, borrower, stakeholder, or liquidity provider.

Updated on: 14/12/2024