Decentralized Finance
If you’ve been involved in the blockchain or cryptocurrency industry for more than a short period of time, then you’ve probably come across the terms “decentralized finance” or “DeFi” (Decentralized Finance) in more than one report.
DeFi has grown rapidly in popularity in the years 2019, 2020 and is now one of the most important uses of blockchain technology. Here you will learn what you need to know before trying it out on your own.
In a nutshell, Decentralized Finance is a term used to describe the decentralized financial tools, protocols, and platforms people use to manage their money, without having to rely on traditional financial infrastructures such as banks, remittance platforms, and government currencies.
Built on decentralized blockchains, DeFi applications operate without any centralized government entities and allow users to interact with each other in a completelyunreliablemanner, as smart contracts automatically keep counterparties safe in a transaction.
Advantages for DeFi users
Arguably the most important advantage of DeFi applications is their accessibility. Since there is no governmental entity with a dominant role, and there are no regulations or rules to abide by. DeFi apps can be accessed by anyone — no matter where in the world they reside. Anyone with a cryptocurrency wallet and internet connection can interact with the world of the Decentralized Economy — without credit checks, KYC, or other barriers to entry.
This is especially important for the 1.7 billion adults worldwide who do not have access to a bank account. Through DeFi, these individuals and everyone else now have access to a wide range of unlicensed protocols, providing many of the same features as banks.
But DeFi goes beyond providing standard financial services to those who need them. It presents a completely original system based on public access and transparency, ensuring that participants can control exactly what is happening behind the scenes if they wish. It achieves this while not having reliable third parties (3rd parties) and costly intermediaries, thus reducing the cost of access to a minimum.
In addition, DeFi gives individuals a way to easily profit from their digital assets by contributing to lending pools used to provide collateralized loans to borrowers and deposit assets in liquidity pools, which allow investors to exchange their assets on decentralized exchanges.
The most common uses of DeFi
Despite being a relatively new industry, Decentralized Finance has grown significantly in recent years, and the number and variety of DeFi applications have also multiplied.
Today, there is a DeFi alternative to almost every major financial service you already use, while some applications for DeFi technology are completely unique and made possible thanks to peer-to-peer blockchain technology.
We will get to know some of the most common cases of use in DeFi below.
Open protocols for loans:
DeFi lending protocols, such as Compound and Aave, allow users to lend and borrow digital assets in a safe and reliable manner. Borrowers deposit funds as collateral and usually pay a fixed interest rate, while lenders earn a variable return on their assets.
Important: Most popular DeFi apps have been tested in their smart contracts and are generally considered safe to use. However, less established or newer apps may not necessarily be safe to use. As always, your tokens can be at risk every time they are moved in addition to your wallet.
Automatic Market Maker (AMMS):
AMMs are DeFi applications that create auto markets using mathematical formulas to determine the price of a token based on the ratio of assets stored in the platform’s liquidity pools, rather than supply and demand like most central exchanges. For example, if there are 10 ETH and 100 UNI in the ETH/UNI pool, then each ETH is worth 10 UNI. This ratio can change over time as traders trade their ETH and UNI, changing the amount of any token in the pool. Ross Bulat explains in depth how this system affects the value of each token in a Uniswap group in a recent publication.
Decentralized security:
Decentralized security protocols like Nexus Mutual allow users to protect themselves from a wide range of risks in the DeFi sector, such as hacks, thefts, flash crashes, and just about anything else. Anyone can also contribute to insurance groups to earn a return on taking a risk.
Synthetic Asset Version:
Synthetic Asset issuance platforms allow users to create a variety of crypto tokens that mimic the price or features of another digital currency, real asset, or financial product. For example, a synthetic token that tracks the price of a large stock like Amazon (NASDAQ: AMZN) or Google (NASDAQ: GOOGL). Synthetics give cryptocurrency users a way to realize trade and gain exposure to complex financial products through a single token (such as ETFs, options and basket funds) and participate in markets that would otherwise be difficult to access.
Inference
Over the past two years, the total value of tokens locked to DeFi tools and protocols has increased from $203 million to $9.53 billion representing an increase of over 4,500%. During this time, the DeFi industry has skyrocketed, interest among developers and crypto companies, and more companies than ever before are developing and launching their own DeFi applications.
However, while many DeFi platforms actually act to return financial independence to users and provide access to new, potentially liberating, or profitable opportunities, not all of them are safe to use and some are scams. With that in mind, it’s important to do your due diligence before investing in or using any DeFi platforms and only risking what you can afford to lose.