DeFi is an acronym for Decentralized Finance. This generally refers to digital assets, smart contracts, protocols, and DApps (decentralized applications) that are built on Ethereum. DeFi is financial software built on the blockchain that systematically pieces together like money blocks. According to DeFi Purse, DeFi locks over 500M USD in their applications. Applications include stablecoins, DEXs, lending, derivatives, payments, etc. DeFi usually refers to as Open Finance, which aims to remove restrictions that limit people’s access to traditional financial services. In simple terms, DeFi uses cryptocurrencies, blockchain technology, and smart contracts to provide financial services.
DeFi is the popular acronym for Decentralized Finance. The technology garners lots of popularity and has grown into one of the biggest sectors in the crypto space. You can imagine Decentralized Finance as a global alternative to ALL financial services – savings, loans, investment, insurance, and many more – that you would use. DeFi allows these financial services to be accessible to everyone with just a smartphone and internet connection. Through the usage of cryptocurrencies, Blockchain technology, and smart contracts, DeFi is able to provide revolutionary financing technology.
Decentralized Finance intends to build a financial system that is accessible to everyone and removes the need to trust and rely on central financial authorities. The technology to achieve independence from central authorities is already here. Namely the internet, blockchain, and cryptography.
In traditional finance we rely on 3rd party central authorities to verify transactions. However, in the context of the blockchain and cryptos, the users can verify transactions. Some may say this is in line with one of the core values of cryptocurrency, “Financial Freedom”.
As one of the most important aspects in the crypto-space. The codes are not written by the employees of institutions or have institutions managing them. Instead, the code is written via smart contract and they deploy it on the blockchain. Anyone can write these smart contracts and nobody has control allowing complete decentralization.
On the Blockchain system allows users to build a strong bond of trust on the platform. The transparency of the code on the blockchain allows everyone to see and audit. Now you may wonder if all transactions are transparent then aren’t the user’s privacy in danger? While all transactions are transparent, the user’s identity is made anonymous using code.
Perhaps, one of the most exciting features of the system. This allows EVERYONE to have access to the same DeFi services no matter where you are. Technically speaking, this allows anyone with internet access to have a wide array of financial services. With DeFi, anyone with an internet connection and a smartphone can gain access to financial services. Due to its permissionless nature, users don’t have geographical restrictions. So even when they block IP addresses, users can still access the network remotely via VPN. In contrast, most traditional financial services limit is geography. (e.g. a North Korean citizen would not be able to open a bank account in HK) Apart from geographic limitation, traditional financial services also favour the wealthier population. Clients with more assets typically enjoy better rates and have access to wealth management tools. DeFi minimizes the inequality and users can enjoy similar services regardless of size.
Is another important feature of the DeFi platform. This allows anyone to participate, create, and use DeFi apps. Users do not have to interact with a financial institution and can instead interact directly with the smart contracts from their smart wallets.
This is one of the reasons why more and more people are starting to use DeFi services. If a user does not like the interface of a dApp, they can easily use another interface or even build their own. This allows users to choose and alter the DeFi services best fittingly to their own needs.
A feature on the DeFi platform that allows applications to be built by combining other DeFi products. Hence a wide variety of applications or products can be put together to create something entirely new.
Cryptocurrency’s design is to be decentralised, transparent, trustless, permissionless and censorship-resistant. They use decentralized control as opposed to central banking systems. Therefore, DeFi aims to provide permissionless and transparent financial services to anyone and everyone. So the advantages of decentralised financial products are similar to the original vision of public blockchain:
With the surveillance of government agencies and large companies, the closely monitor our spending habits and financial statuses. Looking at this data, merchants advertise products that “fit” our need and banks calculate a credit score that determines access to products such as loans. In the context of DeFi, they don’t require personal identity to enjoy the service. The system will provide services according to the status of your cryptocurrency wallet address. Apart from financial privacy, the use of smart contracts also minimise human error and improve efficiency. Using public blockchains like Ethereum, we can also benefit from the immutability and censorship-resistant nature of blockchain technology.
Decentralized Finance intends to build a financial system that is accessible to everyone and removes the need to trust and rely on central financial authorities. The technology to achieve independence from central authorities is already here. Namely the internet, blockchain, and cryptography. In traditional finance we rely on 3rd party central authorities to verify transactions. However, in the context of the blockchain and cryptos, the users can verify transactions. Some may say this is in line with one of the core values of cryptocurrency, “Financial Freedom”.
The greatest opportunity of DeFi is that it can literally benefit everyone who can access it. Traditionally central authorities such as governments and banks have been the issuers of currencies that underpin our economies. People trust these authorities to manage and provide regulation for the supply and circulation of currency. Overtime, societies place an enormous amount of trust into these institutions ultimately giving them unfettered power over currencies.
The expectation is for people to trust the government not to print too much money. We expect the banks to safeguard and store our money. We trust institutions with our investments and assets. The reality of the current situation is that this trust is objectively undeserving. “Absolute power corrupts absolutely” and with the current climate of unlimited quantitative easing and printing endless money. This creates a vicious cycle that will eventually end unfavourably for those that have money with the financial institutions. DeFi provides a much needed solution for people to reclaim their financial freedom and unshackle themselves from the traditional financial system.
Just like what the name sounds like, Stablecoins are cryptocurrencies that are extremely stable. These currencies are not meant to be volatile like Bitcoin, Ethereum, or others. Many of these assets that peg to another asset like USD or Gold. Stablecoins are exceptionally useful when it comes to cross-border transfers, saving wealth, merchant payments, and being your own bank without price volatility! Furthermore, several governments and banks are looking to create their own stablecoins. These include China with their DCEP, US Fed Reserve with their digital dollar, and big banks like JP Morgan issuing their JPM coin.
Some popular USD-pegged stablecoins are:
Similar to existing financial services, lending and borrowing plays a crucial part in finance. Users who are looking to earn interest/yield can deposit their funds into a pool. As it functions the same as the traditional marketplace, they do not place their funds place in a lock, and can be withdrawn anytime. This creates high liquidity within the system allowing borrowers to tap into the pool whenever they want. A few leading services include Compound, Aave, Maker以及 Atomic Loans. Compound has seen significant growth recently with the introduction of their COMP token.
Investing is probably one of the most exciting parts of financial services. The buying, selling, and trading of crypto assets is certainly gaining massive adoption by many traditional investors. With DeFi, users are able to invest in stocks, gold, or any assets. This is done through the crypto-based synthetics that allows users to invest in stocks like TESLA and AAPL. So there are quite a few systems that provide such services, these include: UMA, Synthetix, 或 Market protocol. And of course, if you’re more in the advance category, you can also trade options and futures.
This can be done with DeFi protocols like Convexity, Futureswap, 以及 dYdX. We can even trade margins and leverages with protocols like Fulcrum, Nuo, 以及 DDEX. The DeFi system even allows you to bet against Trump’s next election via Augur. If you’re new to investment and need help with crypto investing, you could also set up a Set Protocol, where you will be given automated trading strategies. DeFi truly brings the financial services to everyone around the world, with as little as $1, everyone can have access to the same financial tools.
Given the newness of the DeFi system, there are still challenges that the platform faces. This is why insurance plays such a large role in ensuring the safety of users. Two leading insurance service providers in the DeFi space are Nexus Mutual 以及 Opyn. In order for users to protect themselves against unforeseen harm, be sure to protect yourself and your digital assets.
Developing exchanges are probably one of the first use cases for DeFi. The Decentralized Exchanges (DEX) allows users to exchange crypto assets freely on different platforms. Without a need to verify their identity or even sign up, users are able to truly experience a decentralized platform. Decentralized Exchanges serves as a great platform for users wanting to take part in crypto trading while also earning passive income by providing liquidity to markets.
The current state of exchanges (CEX / P2P) is on the basis of trust. Either you trust the exchange or some other counterparty. By using blockchain and smart contracts, trust in a third party is no longer necessary to facilitate an exchange. Hence a decentralised system will be the platform to ensure both parties have sufficient assets and execute the swap at the price they agree upon. In other words, without the central clearing house, users have full custody of their funds and lower exposure of counterparty risk.
Centralized exchanges (Bitfinex, Poloniex, etc) allow users to margin trade cryptocurrencies. A borrowing market is built into the exchange and users can lend their assets to earn interest. Above all the system on a basis of trust; a hack could occur on an exchange, founders can exit without repaying users, and systems can go down. So by decentralising the lending market, users can lend or borrow peer to peer. So, in some platforms, they combine the market into a large liquidity pool where users can lend, borrow, deposit and withdraw 24/7. The most well-known platform that uses blockchain technology for lending services is MakerDAO. A borrower would lock up Ether as collateral and borrow a stablecoin, DAI. The borrower receives a margin call if the ETH in a lock falls below 150% of the value they are borrowing. The entire process, including liquidation, is transparent and on-chain.
As important as all the other financial services are, payment plays a crucial role in allowing more users to adopt to the DeFi platform. With the DeFi platform, the future of payments will be much simpler. It can be done through a mobile phone and we can imagine the user’s experience to be very similar to ApplyPay or WeChat Pay. With these possible changes in the payment landscape, it will only be a matter of time for users to adapt to the new payment format.
Liquidity and accessibility have been key hurdles for most DeFi projects, but we can see this is being alleviated with the introduction of futures. For example, FTX lists perpetual futures for KNC (Kyber Network), allowing traders to take long or short positions with up to 100x leverage. The market’s reaction was positive and KNC/BTC is now testing new highs for 2020.
A lingering risk lies in security issues. Chinese DeFi protocol, dForce, lost $25m of users’ funds during a hack in April. While authorities were able to track the IP and recover the funds, such events still keep a fair share of users away.
DeFi native tokens have outperformed other cryptocurrencies in the past month. MKR hit a bottom at $190 in March and had a rally to 3x in just 90 days. DeFi is similar to centralised exchange tokens. So DeFi native tokens benefit and gain value from increasing usage of the exchange or service provided by the protocol.
While 2019 was a great year for centralised exchange tokens because of massive demand for IEOs and the emergence of new futures & derivatives, the chart below demonstrates a new cycle where DeFi native tokens are playing catch-up to centralized plays.
The DeFi platform is definitely something to look out for and a revolutionary tool that will replace our existing financial services. With more and more users looking to adopt DeFi services, it will be interesting to see how DeFi or other types of Blockchain technology will integrate into our lives. The future of DeFi is bright and it is just starting its conquest towards traditional financial sectors.
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