How Important Are Ethereum and NFTs to Decentralized Finance?
Reading Time: 5 minutesNFTs and Ethereum are central to DeFi, but just how vital are they?
The world of DeFi has grown and diversified massively over the past few years, with hundreds of platforms offering people a new way to deal with their finances. Within this realm are Ethereum, the world’s most popular blockchain, and NFTs. But what roles do Ethereum and NFTs play in DeFi, and are they essential to this industry?
What Is DeFi?
DeFi, short for decentralized finance, is a sector of the financial industry linked with cryptocurrency, blockchains, and Web3. Most financial institutions and firms are centralized, meaning an individual or group of individuals are responsible for decision-making. DeFi platforms, on the other hand, value decentralization.
Within a decentralized ecosystem, all the stored data and control is spread across multiple connection points (nodes). This ensures that no one entity has total power over a network, vastly reducing the chances of corruption and malicious takeovers. Decentralized networks also value transparency, using distributed ledger technology (DLT) to display transactional history publicly.
DeFi platforms use cryptocurrencies instead of traditional tender for lending, borrowing, staking, investing, and payments. Because most cryptocurrencies are decentralized, they suit the DeFi industry well. A decentralized platform plus a decentralized asset is the perfect combination for many, as it brings transparency, security, and privacy together.
But how do Ethereum and NFTs fit into this equation?
Ethereum in Decentralized Finance
Ethereum is a widely popular blockchain on which hundreds of decentralized projects are built. The Ethereum network was launched in 2013 by Vitalik Buterin, a Russian-Canadian programmer who conceptualized the blockchain at just 19 years old. Buterin became a billionaire at 27 after Ethereum hit the mainstream in crypto and DeFi. So, why has this blockchain become so popular?
Many well-known blockchains serve the sole purpose of processing a single cryptocurrency’s transactions. Bitcoin, Dogecoin, and Litecoin are all examples of such blockchains. But blockchains can also be designed to build decentralized projects, with Ethereum being the most common example.
While Ethereum does have a native currency, known as Ether or ETH, developers can also create decentralized projects on top of Ethereum that use tokens specific to that project, not ETH. Take Uniswap, for example. Uniswap is a decentralized cryptocurrency exchange on the Ethereum blockchain with a native token known as UNI. UNI can be used within the exchange to pay fees and vote on governance proposals.
Ethereum hosts a wide range of additional DeFi projects, including:
- Shiba Inu
- MakerDAO
- SushiSwap
- Compound
- Aave
- Curve Finance
- The Sandbox
- Decentraland
- PancakeSwap
The names listed above are just a few of the projects based on Ethereum. All in all, the blockchain hosts more than 200 DeFi projects, 177 of which have been built on the network (as reported by DeFi Prime). This means that a vast proportion of the DeFi industry exists on the Ethereum blockchain, making it an undoubtedly crucial element.
Various other blockchains host DeFi projects, including Zilliqa, Solana, Avalanche, and the BNB Smart Chain. These all play a role in the DeFi, but none hold a candle to Ethereum’s popularity and choice.
Ether, Ethereum’s native cryptocurrency, also has a solid foothold in the DeFi industry. Because so many DeFi projects are built on the Ethereum blockchain, Ether can be used as a form of payment for services. Alternatively, Ether can be used as collateral on DeFi borrowing platforms, such as MakerDAO. There’s no doubt that this blockchain and its native asset form an important cog in the machine that makes decentralized finance.
But how do NFTs compare? Do these assets play a key part in DeFi, or do they take a back seat?
NFTs in Decentralized Finance
Non-fungible tokens (NFTs) rose to prominence in 2021 when investors began noticing the potential profits that could be made by trading these digital assets. An NFT is essentially a token that represents ownership over a piece of digital content, such as an image, video, or sound file. Unlike typical cryptocurrencies, one NFT cannot be directly exchanged for another, as there is no one price that each holds, and they cannot be divided into equal parts that maintain the same value. Because of this, they are non-fungible.
So, how do NFTs work in DeFi?
Let’s start with proof of ownership. As previously mentioned, NFTs can be hugely beneficial in proving ownership of a virtual item. But these assets can also help in copyright ownership, royalties, and licensing. For example, a user could hold an NFT to show that they have the right to share or reuse a certain piece of content.
On certain DeFi platforms, NFTs can be used as collateral. For example, say you wanted to borrow a holding of a specific cryptocurrency from a DeFi platform. To do this, you’ll often need to deposit collateral, which is an amount of money in the form of a different asset that acts as your security.
NFTs have a particularly interesting purpose in DeFi-based gaming. In play-to-earn (P2E) crypto games, NFTs are often used to trade virtual in-game assets, like land, outfits, avatars, weapons, etc. On top of this, game-based NFTs can sometimes be sold on marketplaces for a profit. For example, the Axie avatars in Axie Infinity can be sold in exchange for Ether.
Lastly, NFTs could prove useful in tackling curve model issues. The curve model addresses the spread of liquidity across DeFi, specifically within crypto liquidity pools. But following this model can lead to stagnant liquidity that is never given back to the providers, which poses a problem.
With NFTs, providers can select their desired prices for providers so that their profits and capital can be more easily monitored and evaluated. NFTs can also provide risk reduction for liquidity providers by offering this ability.
Most NFT and DeFi Projects Are Built Using the Ethereum Blockchain
But Ethereum and NFTs sometimes coalesce within DeFi, with most NFTs and NFT-based projects existing on the Ethereum blockchain. If you’ve researched NFTs, you may have noticed that many marketplaces only allow users to buy NFTs with Ether. Other blockchains support NFTs and DeFi, but Ethereum is the most popular.
This is because the majority of NFTs use the ERC-721 token standard, which is based on Ethereum. So, in many ways, NFT projects often rely on the Ethereum blockchain, which further stresses the importance of Ethereum in DeFi. With so many Ethereum-based NFTs out there today, there’s no doubt that these two technologies regularly interact.
Overall, NFTs aren’t quite as important in the DeFi realm as Ethereum. While these assets certainly have applications on certain DeFi platforms, they don’t sit at the center of the industry in the same way as Ethereum.
Ethereum and NFTs Form Key Parts of the DeFi Market
While Ethereum certainly has more prevalence in DeFi than NFTs, both play integral roles on various platforms. While Ethereum already forms a principal part of the DeFi industry, NFTs certainly have the potential to be applied in various ways. Time will tell how Ethereum and NFTs will continue to perform in DeFi, but chances are we’ll be seeing them for a while.
Reference: https://www.makeuseof.com/how-ethereum-nfts-defi-important/
Ref: makeuseof
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