In our previous post, we discussed the fundamentals of decentralized finance and NFTs. Now we can take a deep dive into DeFi and all of its benefits.
Consider a worldwide, open alternative to every financial service you use today — savings, loans, trading, insurance, and more — that is available to anyone in the globe who has a smartphone and an internet connection.
On smart contract blockchains such as Ethereum, this is now achievable. “Smart contracts” are blockchain-based programs that can operate automatically when specific circumstances are satisfied. Developers may use smart contracts to create significantly more complicated functionality than merely sending and receiving cryptocurrency. These programs are now referred to as decentralized apps, or dapps.
A dapp is an app that is produced and controlled by a decentralized entity or company rather than a single, centralized firm or corporation.
DeFi dapps enable you to produce stablecoins (cryptocurrency whose value is fixed to the US dollar), lend money and earn interest on your crypto, take out a loan, trade one asset for another, go long or short on assets, and execute automated, advanced investment strategies.
How does DeFi function?
Aave, Maker, and Compound are three of the most popular projects. These are technologies that let you to borrow cryptocurrency instantly—and often in big amounts if you can demonstrate your ability to repay the loan in a single transaction. You may also make money by lending out cryptocurrency.
Then there’s 1Inch, a decentralized exchange that allows you to trade any Ethereum-based token you choose or earn money by adding liquidity to the market for that token. DeFi is also about synthetic assets, such as Synthetix’s tokenized equities or Maker’s decentralized stablecoin, DAI, the value of which is decided algorithmically by the protocol. Other services, for example, non-custodially migrate Bitcoin to Ethereum or provide decentralized price oracles, which, among other things, allow synthetic assets to accurately peg themselves to their non-synthetic counterparts.
What Are the Uses of Decentralized Finance?
Decentralized financial protocols, ranging from DAOs to synthetic assets, have opened up a world of new economic activity and potential for people all over the world. The extensive list of use cases provided below demonstrates that DeFi is much more than an emerging ecosystem of initiatives. Rather, it is a comprehensive and integrated endeavor to construct a parallel financial system on Ethereum that competes centralized services in terms of accessibility, resilience, and transparency..
You are the custodian of your own crypto assets with DeFi protocols. Crypto wallets such as MetaMask, Gnosis Safe, and Argent enable you to engage with decentralized applications to accomplish everything from buying, trading, and transferring crypto to earning income on your digital assets in a simple and safe manner. You own your data in the DeFi space: MetaMask, for example, encrypts your seed phrase, passwords, and private keys and keeps them locally on your device, ensuring that only you have access to your accounts and data.
Analytics and data
DeFi protocols provide significant advantages for data discovery, analysis, and decision-making around financial opportunities and risk management due to their extraordinary transparency around transaction data and network activities. The rapid development of new DeFi applications has resulted in the creation of a plethora of tools and dashboards, such as DeFi Pulse, that assist users in tracking the value locked in DeFi protocols, assessing platform risk, and comparing yield and liquidity.
Tools for developers and infrastructure
Composability is one of the basic design principles of DeFi protocols, which means that different components of a system can simply connect and interoperate. As evidenced by the large range of integrated DeFi applications, composable code has generated a significant network effect in which the community continues to build on the work of others. Many people compare DeFi development to constructing with legos, hence the increasingly common moniker “money legos.” Ethereum developers and product teams can now build and launch DeFi protocols with the full-stack tooling and security integrations they require, thanks to Truffle’s smart contract libraries, Infura’s API suite, and Diligence’s security tools.
DEXs are cryptocurrency exchanges that operate without a central authority, allowing users to transact peer-to-peer while maintaining control over their cash. Because crypto assets are never in the custody of the exchange, DEXs lessen the possibility of price manipulation, as well as hacking and theft.
DEXs also provide token projects with liquidity that typically rivals that of centralized exchanges, without the need for listing fees. Only a few years ago, projects would have to pay millions of dollars to have their coin published on a centralized market.
DeFi’s modularity has opened up options for product developers to integrate DeFi protocols directly into platforms across a wide range of industries. Because of their built-in economies and creative incentive models, Ethereum-based games have become a prominent use case for decentralized finance. PoolTogether, for example, is a no-loss audited savings lottery that allows users to buy digital tickets by depositing DAI stablecoin, which is then pooled and lent to the Compound money market protocol to earn interest.
Lending and borrowing
Some of the most extensively utilized applications in the DeFi ecosystem are peer-to-peer lending and borrowing protocols. Compound, for example, is an algorithmic, autonomous interest rate protocol that connects with and underpins a plethora of DeFi systems such as PoolTogether, Argent, and Dharma. Compound allows users to earn interest on crypto that they have contributed to the lending pool by creating interest rate marketplaces on Ethereum. The Compound smart contract matches borrowers and lenders automatically and calculates interest rates based on the borrowed-to-supplied asset ratio. Compound is a clear example of the DeFi space’s exponential opportunity: as more products incorporate the Compound protocol, an increasing number of crypto assets will be able to earn interest even when idle.
DeFi protocols offer a variety of online markets that enable users to exchange products and services globally and peer-to-peer—everything from freelance coding assignments to digital collectibles to physical jewelry and garments.
Peer-to-peer payment is likely the most fundamental use case of the DeFi space and the blockchain ecosystem in general. Blockchain technology is designed to allow users to exchange cryptocurrencies safely and directly with one another, eliminating the need for middlemen. DeFi payment solutions are opening up the economy for underbanked and unbanked people while also assisting large financial institutions in streamlining market infrastructure and better serving wholesale and retail consumers.
Many DeFi apps, by utilizing lending pool protocols such as Compound, offer interest-bearing accounts that can yield exponentially more than typical savings accounts, based on a dynamic interest rate connected to supply and demand. Popular savings applications include Argent, Dharma, and PoolTogether, a no-loss savings game in which users receive their whole investment regardless of whether they win or lose.
Users will be able to stake their ETH and receive rewards as validators or through staking providers once the Ethereum network converts to a Proof of Stake consensus process with Ethereum 2.0. Staking on Eth2 is similar to having an interest-bearing savings account in that stakers receive interest (rewards) for verifying blocks on the Ethereum network.
Synthetic assets, like stablecoins, are crypto assets that provide exposure to other assets such as gold, fiat currencies, and cryptocurrencies. They are backed up by tokens that are locked inside Ethereum-based smart contracts that include built-in agreements and incentive systems. The Synthetix protocol, for example, employs a collateralization ratio of 750 percent, which aids the network in absorbing price shocks.
Something extraordinary is happening in the open financial system – cryptocurrency is putting money online, and we’re seeing a quantum jump in what’s possible in terms of money functioning. It’s a once-in-a-lifetime chance to witness the birth of an entirely new industry. At first, the DeFi space will be playing catch-up with the financial services business. But, in the long run, it’s difficult to predict what breakthroughs will emerge when the ability to construct financial services is democratized to anyone who can write code.