Overview
The world of digital assets is growing and changing very quickly. Your clients, customers, executive management, and board are likely all asking you about this space – and for good reason.
At the time of this writing, the crypto market now has a market cap of more than $2 trillion and the number of crypto wallets has ballooned to more than 260 million. Meanwhile, money that is “locked” in decentralized finance (“DeFi”) pools has skyrocketed to more than $80 billion in a matter of months, and there is now more than $120 billion in stablecoins. Clearly, there is retail and institutional interest in this space, but the infrastructure and operational support models for digital assets differ from traditional assets, and understanding these differences is key to being able to deliver products and services to your customers.
Our purpose here is to help create the basic building blocks of knowledge on digital assets – touching on the foundational layers of how digital assets are built and work, what the market looks like, who the players are, how the capital markets work, and how to think about the impact it can have on your business. This paper will discuss the basics of blockchain and discuss what blockchain is, how it works, and what you need to know about public and private keys. You can learn more on other topics at www.fireblocks.com/academy.
Table of Content
Decentralized Finance (DeFi)
DeFi stands for Decentralized Finance, which means that there is no one central party facilitating or controlling financial transactions – it’s almost entirely peer-topeer based.
How does DeFi work in practice? Within traditional financial markets, customers put money into a savings or checking account and it earns a yield. The bank then takes that money and lends it out to retail or corporate clients at a higher yield and keeps the difference (traditional spread lending).
Simplified Traditional Banking Example
In a DeFi scenario, instead of a customer giving their money to a bank, they pledge their digital asset (Bitcoin, Ethereum, etc.) into a pool (e.g. smart contract) that any borrower can access (borrower positions are typically well over-collateralized) and are paid interest in the token that has been pledged (e.g. if Bitcoin is pledged, interest will be earned in Bitcoin). This is all done in a peer-to-peer format, and is relatively frictionless as it is all executed through smart contracts and rates are set based on supply and demand. Proponents of DeFi will also point out that institutions or individuals have complete control of their money at all times.
Simplified DeFi Example
There are four main areas of DeFi:
Permissioned DeFi
Today, DeFi liquidity pools are mainly permissionless. This means that anyone, including individuals or institutions, can access these pools and participate as a lender, borrower, staker, or liquidator. For regulated financial services institutions, this can present potential problems from a KYC (Know Your Customer) and AML (Anti-Money Laundering) perspective.
To solve these KYC and AML-specific issues, some DeFi protocols are launching Permissioned DeFi pools. Permissioned pools are separate liquidity pools where the participants are “whitelisted” (e.g., a KYC check has been performed). Anonymity of the participants is still preserved, but participants can now have confidence that they are transacting with counterparties that have been vetted by the DeFi protocol or their whitelisting service.
