One of the key boosters that triggered capital accumulation in the crypto market in 2020 was decentralized finance or DeFi. Decentralized Finance (DeFi) is a financial service built on blockchain technology that offers users access to an open, efficient and comprehensive financial system.
This technology allows you to place deposits on the blockchain, lend against the security of cryptocurrencies without regard to the borrower’s credit history, and at the same time guarantees complete anonymity of the trading process.
How Decentralized finance works
Through smart contracts, DeFi platforms provide free funding, thereby providing everyone with access to capital. The decentralized finance market is streamlined to include many use cases, including decentralized exchanges, lending platforms, prediction markets, and more.
Decentralized finance excludes the participation of intermediaries, instead of which there are smart contracts that allow the creation of trust protocols. Smart contracts are self-executing transactions that represent a programmed agreement between a buyer and a seller. This is why DeFi provides access to financial services without third parties.
It is not the crypto assets that circulate on DeFi platforms but derivatives or operating tokens. For example, when depositing bitcoins on the Compound platform, the user receives operational cBTC tokens. Further, these tokens can be locked on deposit for passive income or used to buy other tokens.
Decentralized Finance Benefits and Features
The transparency provided by the essence of blockchain technology is considered a key advantage of DeFi. Here, information about all trading operations, liquidity placement in pools, its withdrawals, the total amount of funds locked in the protocols is publicly available.
The functioning of smart contracts practically eliminates human errors and the associated possibility of manipulation. The basic tenet of DeFi banking is who holds the keys to finance.
DeFi industry is based on decentralized wallets, the work with which requires the user to handle public and private keys and add custom tokens of a particular protocol to their wallet. But even advanced users of DeFi banking are so far limited only to the Ethereum blockchain, while there is significant demand for other popular blockchains, like Bitcoin, Ripple, and others.
That is why, for example, tokenized bitcoin (wBTC) appeared, thanks to which crypto enthusiasts have the opportunity to conduct transactions with it on the Ethereum blockchain. Remember, when placing liquidity in the hope of making a profit, users are often faced with excessive dynamics of annual interest rates, due to which many of their expectations may not be met.
Decentralized Finance Applications
Centralized and decentralized finance are two opposing approaches to organizing systems. The following are examples of DeFi projects, thanks to which you can catch their possibilities.
Lending and Borrowing
This is perhaps the main and really important use case for decentralized finance. Platforms like BlockFi allow users to lend and borrow to other users allow them to do so without intermediaries. According to the loan platform, protocol user interest is paid in stablecoins and cryptocurrencies.
Today, the most popular in loan processing through decentralized finance is the Ethereum blockchain. BlockFi, Compound, and Dharma are also well-known projects.
- The platform operates on Money Market Protocol supporting different Ethereum blockchain-based tokens, for example, USDC, DAI, BAT.
- The compound uses its own cToken (cBAT) currency for loan providers rs and borrowers on its platforms.
- Unlike some other DeFi services, the percentages on the compound are not standing, as depends on market conditions.
- Dharma is a peer-to-peer loan platform that is partly decentralized.
- The platform was built on the base of Ether. Work with DAI, USDC, and Ethereum tokens.
- The percentage of interest vary depending on the token.
- To lend or borrow cryptocurrencies, users need to pay uniform tariffs and set by the asset team.
- This is the company that controls the stablecoin named Dai.
- The platform is built on the base of Ether, where users can lend or borrow crypto DAI and Ether; but, different from peer-to-peer platforms, this service produces crypto from the pooled supply.
- The platform plans to provide borrowers with the ability to put plural various crypto assets as collateral to offset the risks associated with the changeability of a specific worth.
Asset management tools in DeFi decentralized finance function as asset custodians but are not related to banking and commercial services. The system provides users with wallet applications and other tools thanks to which cryptocurrency holders can effectively manage their assets.
Newbies can face difficulties in mastering wallets or the ecosystem as a whole, including diversifying investments, finding exchanges, and more. Asset management tools solve this problem in the case of novice investors.
- A decentralized finance platform is offering users asset management solutions. With the help of ETH and ERC, the company’s clients can manage their capital.
- The platform is completely decentralized, the protocols are managed by the community, and there are no representatives of the central government on the board of directors.
- Decentralized smart wallet based on the MakerDAO protocol.
- Allows users to track their blockchain assets in a decentralized manner, thereby optimizing their funds across multiple protocols.
A derivative is a contract between two or more parties, which varies depending on the underlying asset dynamics. Derivatives in decentralized finance are very flexible as their smart contracts can issue tokenized derivative contracts that are automatically executed. In general, derivatives are used to protect investors from price fluctuations.
- A decentralized financial contracts platform where users swap gross income over Ethereum with exposure to multiple assets.
- On an open-source site, parties can design and create smart contracts, but the contracts are protected by economic incentives.
- Synthetix functions as a tiered exchange and issuing platform where users can mint synthetic assets, including cryptocurrencies, fiat currencies, and derivatives. With Synths tokens, clients can invest in top assets, including Bitcoin, Gold, and US Dollar, as well as Ethereum blockchain stocks.
- The user invests the collateral in the form of Synths tokens and creates a synthetic asset. Then he can exchange it for another asset. No third parties are involved in this independent process.
Insurance remains one of the most important moments in the cryptocurrency space. Investors naturally tend to give preference to platforms that help them ensure their private keys and digital assets, especially against hacks, negligence, and poor governance.
DeFi insurance protocols allow users to comply with smart contracts and digital asset insurance policies by pooling funds. Today, the decentralized finance insurance protocol market is relatively small but has good growth prospects in the future.
- Nexus Mutual is one of the most popular players in this space. It is an Ethereum-based decentralized insurance protocol through which anyone can purchase insurance coverage or participate in the risk-sharing protocol.
- Participants of such a protocol own an insurance pool, having previously invested Ether tokens in it and received NXM tokens in return.
How to Create Your Own DeFi App
- The development and integration of decentralized applications and native cryptocurrency is an option that is actually available in many blockchains. But the most popular are architectures for this are Ethereum and EOS.
- There is also an asset management tool that lets you digitize them – Algorand Standard Asset or ASA. Any token can be added to the ecosystem without facing the problems of lack of access to global markets, difficulties with documentation, and control over financial instruments.
- Tokens that are developed and issued using Algorand are compatible with each other and can be used in parallel. Level 1 smart contracts are used to transfer standard ASA assets.
What are the Prospects for Decentralized Finance?
The DeFi ecosystem grows and develops, striving for status as one of the key constituents in the field of cryptocurrency finance. With financial independence and the absence of intermediaries in important financial transactions, this market has the potential for exponential growth.
The decentralized finance system will definitely continue to develop further. In 2020, the main focus of blockchain engineers was on mechanics for placing and withdrawing liquidity represented in Ethereum and ether-like stablecoins like USDT, WBTC, or DAI using protocols operating on the Ethereum blockchain.
In 2021, the growth point for DeFi will probably be the creation of bridges that will open access to trading, lending, and yield farming services within the framework of a cross-platform protocol using several popular blockchains at once but not just Ethereum.
This concept is often referred to as atomic liquidity management and has been known in the crypto community for a long time but has not yet received widespread use since its final development is still not completed.