DeFi is a protocol or a cryptocurrency industry movement that aims to recreate traditional banking services without centralized technologies.
While cryptocurrency coins create a decentralized store of value separate from any government-backed fiat currency,
Defi creates decentralized financial instruments separate from traditional centralized institutions.
Bitcoin is a quintessential example of Defi; most other cryptocurrencies have relied on central issuers or organizers.
Most Defi platforms take the form of decentralized apps, known as dapps.
These dapps use the series of smart contracts to generate financial transactions, making them faster and more efficient.
It is more affordable than their centralized counterparts because dapps are governed by computer code as it stays neutral and there is nothing like biasedness.
Defi allows people to have control over their money and has interesting ways to utilize it.
The centralized financial industry has long excluded people of modest means, reserving the best instruments for those with more funds, and thus further increasing the wealth gap.
Most of the Defi projects aim to make investment and trading more accessible, with lower minimum investments and platforms which are easy to use from any smartphone with an internet connection, regardless of geographical location.
The rise of Defi
It is understood that this initiative is being flourished through more flexible blockchains i.e smart contracts and a more healthy developer base.
Today, nearly all Defi projects are being built on Ethereum, making it standard default blockchain for many dapps.
Ethereum dominates existing blockchains in the number of applications, application activity, user activity, and also in volume traded/locked (with limitations).
In nutshell, there are many other competitors for the Defi but some of them lack true decentralization or a healthy developer base.
Bitcoin as a part of cryptocurrency emphasizes security, something which is very important in financial infrastructure.
Hence, Bitcoin might be suited for a robust, albeit notably smaller Defi ecosystem.
Bitcoin’s most successful Defi application is so far the Lightning Network.
Other notable Bitcoin Dapps are in the area of decentralized exchanges like Bisq or Sparkswap.
It is tough to determine which protocol or application serves the best and will have the most usage, in the long run, currently the advanced decentralization, programmatic flexibility, and the enthusiastic developer base gives Ethereum ( Eth ) the lead.
Core benefits of DeFi
DeFi can be viewed as a cluster of second layer applications as blockchain is referred to as a general infrastructure layer.
Defi inherits the core property of decentralization and this is only because the blockchain itself is decentralized.
- True decentralization – It enables censorship resistance, worldwide participation regardless of social status, and dispenses trusted the third party.
- Technological infrastructure – Blockchains allow relatively speedy and low-cost transactions/ settlement also ensures the immutability of the financial contracts and contract automation.
- Private keys – This term is referred to as non – custodial in the blockchain ecosystem which means the user is in full control of the money without a trusted party.
- Increased transparency – It ensures minimum agent risks, as asymmetric information is non-existent and the personal interests are governed by a transparent protocol.
- Network effects – A lot of innovation is generated by uniquely combining different projects in layer 2 or even layer 3 applications.
Why it is lacking behind ?
Defi is currently lacking behind the promising theory to adopt it. In favor to adopt decentralized applications, Defi has to overcome major obstacles –
- Accessibility – Blockchains allow accessibility of the Defi all over the globe but it is still unintuitive to user experience. Furthermore, as it is based on cryptocurrencies, converting traditional currencies into cryptocurrencies has to be done as a pre-requirement.
- Liquidity – It is an important for a fact that it ensures efficient pricing in the financial industry. Most protocols are currently unable to compete as efficient low-fee competitors. In the light of double-digit stability fees, MakerDAO is currently not used as a permissionless credit provider but rather it serves as a decentral way to create leverage in Ethereum. By converting ETH to DAI and reinvesting this into ETH, this follows the centralized strategy of leveraged long positions.
- Products are overcollateralized – This is because currently there is no credit scoring or shared collateral which reduces the leverage for professional traders or the opportunity to obtain access to capital that the user does not own.
- Technical risks – Transactions are irreversible in the blockchains as if some bugs arrive or get detected in smart contracts or blockchain layer.
- Operational risks – Due to the failure/manipulation of price feeds (so-called oracles) and complex governance protocols.
- System risk – This problem arrives from the interdependencies of the protocol. This can be observed at MakerDAO’s too-big-too-fail status, arguably the most critical piece of infrastructure within Defi given space’s reliance on oracles and stable coins.
Ethereum as an Obstacle
There are some problems with eth which could potentially create problems for Defi to work :
- Network Congestion – If the usage is high, Ethereum faces clogging issues in the network. The traffic gets collected on the network which results in transactions to be pending, market inefficiency, and delay in information.
- Transaction costs – Transactions are being competed on the basis of chain gas fees. The lower the gas fees of the transactions, the lower would be its priority.
- Timing issues – Blockchain is updated on average every 15 seconds, this is very uncommon for traditional finance. Defi interest and prices are calculated per block and for robust operation, it requires stable block mining.
Defi Use Cases: The best examples of decentralized finance
Defi is an umbrella term for decentralized financial infrastructure, thus a variety of customer-facing applications can be found.
Layer 3 – They aggregate core DeFi infrastructure and provide complexity.
Use Case – Combining Defi platforms allows customers for easier interactions, monitoring, and general better usability.
Example: Ray, InstaDapp, Defi watch.
Crypto Borrowing/Lending – It provides loans to users or businesses in a trustless manner i.e without any intermediaries whereas the lending protocols allow every participant to get interests on crypto coins and stable coins.
Use Case – Market participants are enjoying various benefits :
- Borrower, the ability to buy any asset and selling to another immediately shorting the asset, borrowing utility, and creating leverages.
- Lender, ability to provide capital and earn interest
- Both, Arbitrage and capital work
Example : Compound, Dharma, dydx, bZx
Stablecoins – Stablecoins are cryptocurrencies within the ecosystem, secured to a fiat currency.
Use Case – Trader: Cryptocurrency with minimal volatility as pegged to a fiat currency.
Example : MakerDAO
Defi insurance – Defi insurance protocols allow its users to take out insurance policies on smart contracts, funds, or any other digital asset through pooling individual funds to cover any claims.
Use Case – The purpose of decentralized derivatives is a manifold as the instruments itself like risk management, leveraged trading, betting.
Example: Nexus Mutual, Ethersc, Cdx
Derivatives – Derivatives in Defi offers immense flexibility across multiple assets and platforms. Smart contracts can issue tokenized derivative contracts which are executed permissionless and automatically.
Use Case – Purpose includes risk management, leveraged trading, and betting.
Example : Synthetix, Augur, Tokenset
Defi is currently a space of technical experiments and innovation instead of professional financial operations.
This can be said for the majority of the ecosystem and to fill the gap between theory and practice Decentralized Finance has yet to overcome its core roadblocks:
Low liquidity, unintuitive UX and accessibility, capital inefficiency, hidden risks, and regulation have somewhat suffocated adoption.
These issues might be lessened as the industry matures.
Promising solutions are already on the way making 2020 an exciting year to follow.
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What are Defi apps?
Defi apps is a that platform which provides users with traditional services but in a decentralized and borderless manner that enables anyone across the globe with an internet connection to gain access to financial products and services.
How do you make money with DeFi?
If a beginner is familiar with Ethereum, then it would take a couple of minutes to make money out of it.
And when it’s all said and done, the user earns interest in DAI every block.
A beginner’s guide which breaks down the entire process of getting a wallet, acquiring ETH, and lending out your DAI.
What is the safest Stablecoin?
Tether is the oldest stable coin and by far the most used stable coin but newer – gen fiat-backed stable coins USDC, TUSD, and PAX have made material improvements over Tether, both in their actual performance and their transparency to users.
How does DeFi lending work?
With applications such as Maker and Compound, any individual can take out a loan of any size without having to disclose their identity to a third party in a matter of minutes.
In order to properly function, all loans are secured using cryptocurrencies as the underlying collateral.
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