Decentralized Finance is a system that allows users to make use of financial services such as trading borrowing and lending with absolutely no need for a centralized authority. This is made possible through the use of decentralized applications known as Daaps.
DeFi is not limited to trading alone. You can do just about anything you’ll normally do on traditional banking system in DeFi. These includes: lending and borrowing, insurance, banking and even bonds. Yes. All of which can be easily don with the use of Daaps
This is possible through the use of smart contracts.
According to Wikipedia, A smart contract is a computer program or a transaction protocol which is intended to automatically execute, control or document legally relevant events and actions according to the terms of a contract or an agreement.
For DeFi to work, some money has to be locked into these smart contracts. In other words, a collateral. If you ever come across the acronym TVL, this is what it means. An increase in the TVL signifies growth.
As of July 10, 2001, the total value locked across all DeFi protocols cross-chain is over 110 billion dollars! This is significant when you consider that there was less than $2 billion TVL in DeFi back in February 2020.
The goal of DeFi is to remove any middle men when it comes do finance, and it’s been working so far. However keep in mind that DeFi has its risks too. Because its still very early, and very few people can read and understand how smart contracts really work, there’s a high chance of people loosing their money in DeFi. So do your own research before interacting with any smart contracts.
Some of the key categories you’ll fine in DeFi are:
1: Stable coins
2: Exchanges
3: Derivatives
4: Oracles
5: Lending and Borrowing
1: Stable coins – Stable coins are crypto assets that are pegged to other stable assets such as the United States dollar. The very first of such stable assets is Tether’s USDT. Although there are some serious concerns about Tether’s USD reserves among other things, it is the most used stable coin at the moment. We also have USDC, BUSD and DAI.
Stable coins are created via an over-collateralization method, operate fully on decentralized
ledgers, and are governed by decentralized autonomous organizations.
They make Decentralized Finance accessible to everyone, since they don’t suffer from high price volatility on other cryptocurrencies.
2: Exchanges – Decentralized exchanges (DEX) are a type of cryptocurrency exchange which allows for direct peer-to-peer cryptocurrency transactions to take place. The most popular decentralized exchange is Uniswap, built on the Ethereum blockchain.
They operate without an intermediary organization for clearing transactions, relying instead on self-executing smart contracts to facilitate trading. DEXs take on a non-custodial framework.
3: Derivatives – A derivative is a contract whose value is derived from another
underlying asset such as stocks, commodities, currencies, indexes,
bonds, or interest rates.
Although derivatives is currently only available on centralised exchanges, it is coming to DeFi.
Sooner or later, DeFi users will be able to hedge their positions and decrease their risk when trading.
4: Oracles – Oracles are 3rd party services that provide blockchain smart contracts with off-chain data (real-world information).
They act as the technological mediator between smart contracts and the real-world data. They are designed to relay information from off-chain sources (data outside the blockchain) to an on-chain network. In most cases, the off-chain data is used to trigger smart contracts that need external data in order to execute.
With oracles, DeFi protocols can access off-chain data and relay on-chain data to the outside world as well.
Chainlink is the biggest oracle project in DeFi at the moment. We also have Band protocol, Umbrella Network, and some others.
5: Lending and Borrowing – DeFi takes away the need to have a bank account, going through KYC and providing several records before being eligible for a loan.
DeFi allows anyone to collateralize their digital assets and use this to obtain loans.
You can do this on platforms such as AAVE and Compound.
Some projects even allow you to take loans, using your NFTs as collateral.
In a nut shell, DeFi is good for everyone. There are almost 2 billion people worldwide without a bank account today. A vast majority of those who have today will be happy to close their bank accounts if all conditions are convenient for it and stick to DeFi alone.
This will take some time however.
Decentralized Finance offers so many possibilities that traditional finance cannot offer. But this comes at great risk.
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