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Published by: 21:34, 03 October 2020

What is decentralized finance (DeFi)?

Decentralized finance - often referred to as DeFi - refers to the shift from traditional centralized financial systems to peer-to-peer financing enabled by decentralized technologies built on the Ethereum blockchain.

From lending and borrowing platforms to stabelcoins and tokenized BTC, the DeFi ecosystem has launched a vast network of integrated protocols and financial instruments. Now that Ethereum smart contracts have exceeded $7 billion in turnover, decentralized finance has become the most active sector in the blockchain space, with a wide range of use cases for individuals, developers and organizations.

"We are two steps away from a global financial industry running on a common software infrastructure.".

Lex Sokolin, ConsenSys co-head of global financial technology

While our traditional financial system runs on a centralized infrastructure run by central governments, institutions and intermediaries, decentralized finance is provided by code running on a decentralized Ethereum blockchain infrastructure.

By deploying immutable smart contracts in Ethereum, DeFi developers can run financial protocols and platforms that work exactly as programmed and that are accessible to anyone with an Internet connection.

DeFi's breakthrough is that crypto-assets can now be used in ways not available with fiat or "real" assets. Decentralized exchanges, synthetic assets and flash credits are entirely new applications that can only exist on blockchains. This paradigm shift in financial infrastructure offers a number of benefits in terms of risk, trust and opportunity.

Decentralized finance. Key benefits

Decentralized finance leverages key principles of Ethereum blockchain to enhance financial security and transparency, open up liquidity and growth opportunities, and support an integrated and standardized economic system.

  • Programmability. Highly programmable smart contracts automate execution and enable the creation of new financial instruments and digital assets.
  • Immutability. Data coordination with protection against unauthorized access in a decentralized blockchain architecture increases security and controllability.
  • Compatibility. Ethereum's composite software stack ensures that DeFi protocols and applications are designed to integrate and complement each other. With DeFi, developers and product teams can flexibly build on existing protocols, customize interfaces, and integrate third-party applications. For this reason, people often refer to DeFi protocols as "money lego".
  • Transparency. In Ethereum's public blockchain, every transaction is broadcast and verified by other users on the network (note: Ethereum addresses are encrypted keys that are pseudo-anonymous). This level of transaction data transparency not only allows for detailed analysis of the data, but also ensures that network activity is available to any user. Ethereum and the DeFi protocols that run on it are also built with open source code that is available for review, audit and development.
  • Decentralization. Unlike traditional finance, DeFi is defined by its open, unlimited access: anyone with a cryptocurrency wallet and an Internet connection, regardless of their geography and often without the minimum amount of funds required, can access DeFi applications built on Ethereum.
  • Independent decision making. By using Web3 wallets such as MetaMask to interact with financial applications and permission-free protocols, DeFi marketers always keep their assets safe and in control of their personal data.

"The foundations of the new economy begin with borrowing and lending. In 2019, the blockchain industry has incorporated these necessary developments into what has become DeFi ".

Collin Myers, head of global product strategy at DeFi, Codefi

What are the options for using decentralized finance?

From DAOs to synthetic assets, decentralized finance protocols have opened up a world of new economic activity and opportunity for users around the world.

The following exhaustive list of use cases is proof that DeFi is much more than just an evolving ecosystem of projects.

Rather, it is a massive and comprehensive effort to create a parallel financial system based on Ethereum that competes with centralized services because it is much more accessible, sustainable, and transparent.

Asset management

With DeFi protocols, you are the custodian of your own cryptocurrency funds. Crypto wallets such as: Trustee Wallet, MetaMask, Gnosis Safe and Argent, help you easily and securely interact with decentralized apps to do everything from buying, selling and transferring cryptocurrency to earning interest on your digital assets.

In the DeFi space, you own your dаta: Trustee Wallet, for example, stores your passphrase, passwords and private keys in an encrypted format locally on your device, so only you have access to your accounts and data.

Compliance and KYT

In traditional finance, anti-money laundering (AML) and counter-terrorist financing (CFT) compliance is based on "know your customer" (KYC) principles. In the DeFi space, Ethereum's decentralized infrastructure allows the next generation to perform compliance analysis on the behavior of participating addresses rather than the identity of participants. These "know-your-transaction" (KYT) mechanisms help assess risk in real time and protect against fraud and financial crime.

DAO

A DAO is a decentralized, autonomous organization that cooperates according to transparent rules encoded in the Ethereum blockchain, eliminating the need for a centralized administrative facility. Several popular protocols in the DeFi space, such as Maker and Compound , have launched DAO to raise funds, manage financial transactions and decentralize governance in the community.

Data and analytics

With unprecedented transparency of transactional data and network activity, DeFi protocols offer unique advantages for financial opportunity discovery, analysis and decision-making and risk management. The rapid growth of new DeFi applications has spurred the development of multiple monitoring tools and dashboards, such as DeFi Pulse and Codefi Data, which help users track the value captured in DeFi protocols, assess platform risk, and compare returns and liquidity.

DeFi decentralized finance defi
Codefi Data compares returns, liquidity, and other factors across DeFi protocols.

Derivatives

Ethereum-based smart contracts allow the creation of tokenized derivatives whose value is determined by the performance of the underlying asset and in which agreements with counterparties are enshrined in code. DeFi derivatives can represent real assets such as fiat currencies, bonds and commodities, as well as cryptocurrencies.

Developer and infrastructure tools

One of the main design principles of DeFi protocols is the ability to link, that is, different components of the system can easily connect and interact. As seen in the wide variety of integrated DeFi applications, linkable code has created a powerful networking effect in which the community continues to build on what others have created. Many compare DeFi's development process to building out of lego - hence the increasingly popular nickname "lego money".

From Truffle's smart contract, API to Infura package, Diligence, Etherium developers and development teams can now also build Defi launch protocols with the full tooling stack and security integrations they need.

defi
DeFi superuser activity visualization.

DEX

Decentralized Exchanges (DEX) are cryptocurrency exchanges that operate without a central authority, allowing users to make peer-to-peer transactions and retain control over their funds. DEX reduces the risk of price manipulation as well as hacking and theft because crypto assets are never in the custody of the exchange itself.

DEX also gives token projects access to liquidity that often rivals centralized exchanges, and without any listing fees. Just a few years ago, projects were paying millions of dollars to list a token on a centralized exchange.

Some exchanges are implementing a degree of decentralization where centralized servers can host order books and other features, but do not store users' private keys. Popular DEXs in the DeFi space currently include AirSwap , Liquality , Mesa , Oasis and Uniswap .

Games

DeFi's composability has opened up opportunities for product developers to embed DeFi protocols directly into platforms in a variety of verticals. Ethereum-based games have become a popular option for decentralized finance because of their built-in economics and innovative incentive models. PoolTogether , for example, is a proven no-loss savings lottery that allows users to buy digital tickets by depositing DAI Stablecoins, which are then aggregated and lent by complex money market protocols to earn interest.

Decentralized Finance
PoolTogether is a win-win, proven savings game powered by Ethereum.

Identity

Decentralized financial protocols combined with blockchain-based identity systems are an opportunity to help previously blocked users gain access to a truly global economic system. DeFi solutions can reduce collateral requirements for people without additional funds and help assess users' creditworthiness with attributes related to reputation and financial activity instead of traditional data points such as home ownership and income. The DeFi space values data privacy with respect to personal identifying information as well as open access. Anyone with an Internet connection can access DeFi applications while still maintaining control over their data and assets.

Insurance

Decentralized finance (DeFi)-still an evolving space with attendant risks due to errors and breaches of smart contracts. A number of innovative insurance alternatives have entered the marketplace to help users purchase coverage and protect their assets. Solutions such as Nexus Mutual , for example, provide smart contract coverage that protects against unintended use of the smart contract code.

Lending and borrowing

Peer-to-peer lending and borrowing protocols are some of the most widely used applications in the DeFi ecosystem. Compound , for example, is an algorithmic, standalone interest rate protocol that integrates and underpins a long list of DeFi platforms, including PoolTogether, Argent and Dharma. By providing interest rate markets on Ethereum, Compound allows users to earn interest on the cryptocurrency they have lent to a pool of lenders. Compound's smart contract automatically matches borrowers and lenders and calculates the interest rate based on the ratio of borrowed to lent assets. Compound is a compelling example of the exponential possibility of the DeFi space: as more and more products integrate the Compound protocol, more and more crypto-assets will be able to generate interest even when they are idle.

decentralized finance defi
Compound is an algorithmic autonomous interest rate protocol.

Margin Trading

While margin traders in traditional finance can leverage their trades by borrowing funds from a broker (who then generates collateral for the loan), DeFi's margin trading is based on decentralized non-custodial lending protocols such as Compound and dYdX. As smart contracts automate traditional brokerage activities, some have begun to refer to the rise of "autonomous money markets" in the DeFi ecosystem.

Trading venues. Decentralized Finance

DeFi's protocols support a host of online trading venues that allow users to exchange products and services worldwide and peer-to-peer - everything from freelance coding programs to digital collectibles and real jewelry and clothing.

Payments. Decentralized finance

Peer-to-peer payments may be the primary use case for the DeFi space and the blockchain ecosystem as a whole. Blockchain technology is designed so that users can securely and directly exchange cryptocurrency with each other, without intermediaries. DeFi payment solutions create a more open economic system for the unbanked and unbanked population, and help large financial institutions optimize market infrastructure and better serve wholesale and retail customers.

Forecasting Markets

Blockchain-based prediction markets harness the wisdom of the crowd and allow users to vote and trade based on the outcome of events. Market prices then become crowdsourced indicators of event probability. Augur , the popular DeFi betting platform, offers markets predictions of election results, sports games, economic events, etc.д.

Savings

By connecting to credit pool protocols such as Compound, many DeFi apps offer interest-bearing accounts that can earn exponentially more than traditional savings accounts, depending on a dynamic interest rate tied to supply and demand. Popular savings apps include Argent , Dharma and PoolTogether, a lossless economy game in which participants get all their money back whether they win or not.

One area of DeFi that has gained widespread traction around these innovative savings mechanisms is "crop farming". DeFi farming refers to users moving their idle crypto assets across different liquidity protocols to maximize profits. The frenzy of hype around DeFi crop cultivation is not short of memes 🍠

Stablecoins

A stabelcoin is any cryptocurrency tied to a stable asset or basket of assets, such as fiat, gold, or other cryptocurrencies. Stablecoins were originally designed to reduce volatile cryptocurrency prices and make blockchains a viable payment solution. Now they have been implemented in the DeFi space for money transfers, lending and borrowing platforms, and even institutional use cases such as central bank digital currency (CBDC).

Bet

As the Ethereum network transitions to the Proof of Stake consensus algorithm with Phase 0 Ethereum 2.0 , users will be able to bet their ETH and receive rewards either as validators or through betting providers. Betting on Eth2 is similar to an interest savings account: participants receive interest (rewards) for validating blocks on Ethereum.

Synthetic assets

Linked to Stablecoins, synthetic assets are crypto-assets that provide access to other assets such as gold, fiat currencies and cryptocurrencies. They are secured by tokens locked in Ethereum-based smart contracts, with built-in agreements and incentive mechanisms. For example, the Synthetix protocol implements a collateral ratio of 750%, which helps the network absorb price shocks.

Tokenization. Decentralized finance

Tokenization is one of the cornerstones of decentralized finance and a built-in functionality of the Ethereum blockchain. Tokens not only fuel the network, but also open up various economic opportunities. Simply put, a token is a digital asset that is created, issued and managed on a blockchain. Tokens are designed to be secure and instantly transferable, and they can be programmed with a number of built-in features. From real estate security tokens, which are fractional properties, to platform-specific tokens that incentivize the use of a specific application, Ethereum-based tokens have evolved into a secure digital alternative for users around the world to access, trade and store value.

Trading

Trading in the DeFi space encompasses a range of activities, from derivatives trading to margin trading and token exchange, and takes place in an ever-growing and integrated network of exchanges, liquidity pools and trading venues. Crypto traders on decentralized exchanges benefit from lower exchange fees, faster transaction settlements and full custody of their assets. In July 2020, trading volume on decentralized exchanges exceeded $4 billion.

Decentralized finance is the imminent future, good or bad, time will tell. For a complete picture, I suggest reading the review: DeFi Ethereum report for the second quarter of 2020, I am sure you will like it. This review was prepared based on .net

Please share this review on social networks, DeFi technology deserves it.

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