What is DeFi: Learn About Rapidly Evolving Crypto Segment
DeFi, short for “decentralized finance,” is a general term for a group of financial instruments built on blockchain.
The idea is to allow anyone with Internet access to lend, borrow and go to a bank without intermediaries.
Bitcoin, a payment system in which anyone on earth can send money to anyone, was just the beginning of the crypto-revolution. The people who create DeFi apps are eager to take accessibility one step further. Decentralized finance was advertised as a possible solution to lower the barrier of entry for those trying to access bank accounts. And more recently, it is being used by cryptocurrency owners for another purpose: to make more money. So let’s examine crypto segment more precisely.
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What is DeFi?
Taken together, DeFi applications are financial products that run on a public blockchain such as Ethereum. These products do not require permission, and they do not use third parties. Instead of financial intermediaries like brokers and banks, everything is automated in the protocol through smart contracts.
Do you want to take out a loan? You don’t need a bank to hand you money. You can get a loan directly from your peers. Ready to bet on Bitcoin futures and other derivatives? Forget about finding a bookie. You can let the protocols handle it. Want to exchange one asset for another? Decentralized exchanges can facilitate the transaction without a huge cost.
Who Invented DeFi?
There is no specific inventor of DeFi, but DeFi applications first appeared on Ethereum, which was invented by Vitalik Buterin. They have since spread to other networks that use smart contracts to automate transactions. These include Solana, Binance Smart Chain and Avalanche.
What's so Special About it?
First, DeFi is “open,” which means you can use DApps by creating a wallet – often without displaying any identifying information such as name and address. This is theoretically (if not technologically) easier than having a bank account.
Second, you can move funds almost instantly using blockchain, so you don’t have to wait for a bank transfer to complete.
Finally, DeFi applications work together like “Lego money.” This “composability” allows any user to create, modify, mix and match, link or create on top of any existing DeFi product without permission. Unfortunately, this feature may also be DeFi’s biggest weakness, because if a key component like the DAI Stablecoin becomes vulnerable or a bug is discovered in its smart contract, the entire ecosystem built around DAI could collapse.
What Can You do With DeFi?
- Trading
With centralized exchanges like Coinbase and Binance, you rely on the exchange to hold your assets for every trade. Decentralized exchanges (DEX) eliminate the middleman so people can trade directly with each other. Moreover, DEXs like Uniswap and PancakeSwap allow people to add new tokens to trade. Especially with a wide selection of new tokens, like soulbound tokens. The lack of verification increases risk, but also allows people to “get in early” on new assets before they enter the broader markets.
- Derivatives
Sometimes you don’t want to be limited to trading specific coins or tokens. Derivatives platforms like dYdX and Synthetix allow people to do more than just spot trading. For example, users can make leveraged trades in which they bet more than they have, or even create “synthetic assets” that mimic traditional stocks and commodities.
- Lending/Borrowing
If you have a crypto currency, you can lend it to a protocol like Aave or Compound in exchange for interest and/or rewards. Likewise, you can borrow digital assets from such a protocol, which is especially useful if you want to make a transaction. But beware! Most DeFi protocols use overcollateralization, which means that you must deposit more than the amount you want to borrow. If the value of the asset drops too much, the protocol may take away your collateral to avoid a loss.
Many DeFi users use this as a way to earn assets through “income farming,” in which they put funds into an asset pool to earn rewards. Because rates vary depending on protocol and assets, qualified crop farmers move their assets to benefit from the best bets.
How are DeFi Apps Created?
Anyone who can write smart contracts can create DeFi applications. There are several tools for testing and/or deploying smart contracts for Ethereum. Once you download the smart contracts platform, you can create a token that allows the protocol to use the blockchain network. In Ethereum it is the ERC20 token, in Solana it is called SPL, and in Binance Smart Chain it is BEP20.Having a token allows the protocol to interact directly with the blockchain coin. But projects have also promoted their tokens for decentralization. For example, the Compound lending protocol uses COMP as a management token, meaning whoever has this token can make decisions about the protocol code and allocation of treasury funds.
How do I Use DeFi Products?
Anyone can use DeFi products by going to the app’s website and connecting to a DeFi enabled crypto wallet (don’t forget about cryptoinsuranse as well), such as MetaMask on Ethereum or Phantom on Solana. Most DeFi DApps do not require users to provide any personal information or registration. However, because the apps are built on a blockchain, you must use coins from that blockchain to pay for transactions. ETH is required to pay for transactions on the Ethereum network, SOL is required on the Solana blockchain, and so on.
The Future of DeFi
As of November 2020, there was less than $20 billion blockchain in various DeFi products, most of it on Ethereum. By the following year, it was already over $250 billion, with $19 billion coming from Binance Smart Chain alone. If the trend continues and the DeFi maximalists are right, this is just the beginning of a massive DeFi wave. True believers argue that the benefits of an open and decentralized financial system are simply too compelling not to capture trillions of dollars.
Main Problems and Challenges
The active stage of DeFi development came in 2020, the reason for this boom was the coronavirus, which had an impact on the entire economy. Then the citizens of many countries realized that their national currency is too dependent on global trends, so they began to look for ways to circumvent the impending financial crisis. It is the decentralized economy that allows greater efficiency and flexibility when compared to the classical financial and economic model.
Recently, it was clearly demonstrated how actively the DeFi-project can grow. This time, the credit platform Compound was able to increase the total capitalization of its assets by six times in one month: up to $6.5 billion. This is direct evidence that traders and investors are interested in decentralized projects.
The wave of interest in DeFi has not yet ended, but continues to gain momentum. New technologies are being introduced in all economic spheres. Only DeFi will make it possible to work with several platforms at once, which, without this technology, could not form a profitable tandem.
