DeFi is leading a movement to disrupt the traditional financial system. It stands for decentralized finance, which is an umbrella term for all the financial products happening on a blockchain.
The term DeFi was first coined a month after the 2018 FIFA world cup final. Fast forward to 2022 (another world cup year), DeFi has 85+ billion-dollar assets locked in various dApps. With $17 billion locked in its DAO, Maker dApp is the leading financial product offering numerous services.
You may find yourself in a difficult position to keep up with crypto and its jargon. No worries. We have got you covered. Let's dive deep into DeFi.
What is a DeFi (Decentralized Finance)?
DeFi is an ecosystem of all the financial services happening on the blockchain— mostly Ethereum. Decentralized finance does everything that a traditional bank does— allow lending, borrowing, and trading derivatives, assets, and insurance, but faster, cheaper, and without any central authority.
Unlike banks, no one can intervene with your money/assets in DeFi— it’s just you and your hard-earned money.
For Example- In January, Hayden Adam’s (Founder of Uniswap) bank account was shut down by JP Morgan Chase without any notice or explanation. Uniswap is a decentralized exchange, and Hayden tweeted, banks often target members simply for working in the crypto space.
Let’s take another example- When you pay for Groceries with Visa, MasterCard, or PayPal, The money is routed through banks, for its officials to verify, and they possess full rights to stop the transaction.
This manual work demands a lot of time. But with crypto, this can be done in seconds without anyone manipulating it. And the idea was first laid out by the pseudonymous founder of Bitcoin—Satoshi Nakamoto. In Bitcoin’s white paper, he proposed the idea of “a peer to peer electronic cash based on cryptographic proof instead of trust, allowing two users to transact directly without the need of a financial institution or any other trusted third party.”
And often Bitcoin is referred to as the first decentralized finance. And rightly so, DeFi laid its very foundation on Bitcoin’s idea a peer to peer electronic cash and expands on it.
In the DeFi ecosystem, your money is protected by a Smart Contract— an indestructible program/code that runs on a blockchain where ‘code’ is considered the law. Or in other words, smart contracts are a set of instructions that enables a transaction when certain conditions are met. For example- Conditions like ‘Send 10 ETH to X person, if BTC reaches 100k before 2022 according to Binance’ are easily programmable as Smart Contracts.
And most of the things that you have been exposed to in the Crypto space are smart contracts. For example, NFTs, ERC-20 tokens, Decentralized exchanges, and stable coins.
DeFi is an ecosystem of various dApps. DApps are decentralized applications like mobile any applications but not controlled by a single party. DApps are programmed on blockchain as a smart contract that can be any financial product, domain name service, or a DEX.
Currently, the Ethereum blockchain being the pioneer of smart contracts leads the DeFi ecosystem. However, Avalanche, Terra, BnB chain, Solana, Cardano pose stiff competition, and in popular media, they go by the name of “Ethereum Killers”.
DeFi v/s Traditional Financial Systems (banks)
DeFi is Fast & Cheap
With DeFi, you can instantly transfer millions of dollars across the border for less than a 5 dollar fee. On the other hand, Visa or banks charges a hefty sum, are slow and hold the power to pause the transaction.
DeFi Accessible 24/7
DeFi is a code. It is accessible anywhere, anytime, with an internet connection. In contrast, Banks are only accessible for limited hours and are closed on weekends and holidays. While Traditional financial system has to function within the constraints of limited work hours, physical office buildings, manual labor, massive paperwork, and regulatory bodies.
DeFi is Decentralized
There is no one between your money. You are in charge of your assets. While in the traditional financial system, the government and banks have control over your funds.
DeFi is Anonymous
DeFi works straightforwardly requires no identity details, and in most cases, your non-custodial wallet is more than enough to access dApps. In contrast to it, the bank requires your name, address, parent's name, history, and other KYC documents.
What DeFi have to offer?
Instead of Just HODLing your crypto, you can yield high interest using any major dApps that will lend your crypto on your behalf. That dApp keeps a very small cut and functions as a DAO, maintaining the foundation of Crypto— decentralization.
You can almost start earning immediately, the interests will reflect in your wallet daily basis and the amount would be based on the APY selected.
You can yield Annual interest up to 20% by lending to DeFi products like Aave, Compound, Maker DAO, or Celsius. While interests in Crypto assets are only 5-10%, it increases up to 20% for stable coins.
Borrowing is made more accessible with DeFi. You can borrow money from worldwide lenders without any paperwork or credit score. Works on the same lending principal, the amount you lend would be given to a borrower.
Instead, your crypto assets are held as collateral. And if you somehow fail to repay the loan, the assets are used to compensate the lender.
This allows some easy cash flow without actually selling your Crypto assets like ETH or NFTs. Another type of borrowing is termed a Flash loan, which is a smart contract, as everything in DeFi space is. The catch is, it's given without any collateral for a very short period. The transactions are immediately reversed if something goes unplanned.
You can yield high annual returns of up to 20% on your stable coins (without worrying about volatility), which is much higher than any bank in America.
Crypto.com provides 14% APY on stable coins like BUSD, USDC, USDT. Anchor protocol— a DeFi app on Terra blockchain offers a 19.66% annual yield on Terra USD ($UST) stable coin.
Insurance is another big thing in the DeFi space that proves to be much better than centralized insurance companies. It isn’t run by any central body, instead, money is pooled by coverage providers. Anyone can be a coverage provider by locking their assets in a liquidity pool.
Suppose the unfortunate event happens, and the money is given to the insurance buyer, in this case, the provider would lose his/her money. To start in the first place, a coverage provider reaps a very high interest that is paid from the premium buyer’s money.
The conditions are programmed in a smart contract. The policy and terms are decided in DAO by its members. And the real-world data is imported via oracles into the blockchain to improve smart contract insurance.
For example- Insurance can be bought to prevent assets loss during security breaches on crypto exchanges. Or these days, DeFi even has options to cover crop insurance for small African farmers.
Types of dApps and DeFi Ecosystem
DeFi Stable Coin
To minimize the volatile nature of Cryptocurrency, and mostly to build the foundation of DeFi, stable coins were introduced. As the name suggests, its value remains stable and is pegged to fiat (USD). USDT, USDC, Terra USD, Dai coin, and BUSD are popular stable coins.
And if you want government or banks to keep their hands away from your money, stable coins are the way—to save money without actually worrying about volatility, yielding high interests with full control of your funds.
DeFi Decentralized Exchanges (DEX)
It is a platform where you can instantly convert or swap from one token to another without any central authority. Instead, it is governed by DAO and its token holder. Uniswap, Pancake swap, dYdX are some popular decentralized exchanges.
While the US government is closely keeping an eye on regulating DEX, it remains 100 percent decentralized. Unlike centralized exchanges like Coinbase or Binance, you keep your private keys & wallet seed phrase. And DEX could be for you if you often find yourself verbalizing, “Not your keys, not your coins.”
DeFi Borrowing & Lending platforms
One of the largest sectors of dApps is the DeFi borrowing & lending platform, which allows any user from anywhere to lend or get loans with just a crypto wallet.
Some top borrowing & lending dApps are:
Popular DeFi Tokens and it's utility
Terra, hailed from South Korea, is a DeFi ecosystem that consists of Smart contracts and Stable coins. It markets itself as the most deployable blockchain of decentralized stable coins and the dApps ecosystem.
Luna— Terra’s native token that stabilizes its various stable coins like USD, EURO, Chinese Yuan, the Japanese Yen, the British Pound, and the South Korean Won.
Terra made a massive move, purchased bitcoin worth $135 million. Terra UST is a bitcoin-backed stable coin that has 10+ billion worth of BTC in its reserves. With a market cap of $38.25 billion, Terra thrives to bring the DeFi ecosystem and stable coins to mass.
2)Wrapped Bitcoins (WBTC)
One cannot ignore the granddaddy of all cryptocurrencies in the DeFi space. WBTC was introduced to integrate Bitcoin with dApps as most of the DeFi ecosystem operates on the Ethereum network. After being wrapped, Bitcoin transforms into an ERC-20 token, becoming Ethereum compatible. WBTC value always remains in a 1:1 ratio to Bitcoin.
3) Uniswap (UNI)
Uniswap is a decentralized exchange where users can trade or swap ERC-20 tokens. Launched in November 2018, it's a leading decentralized exchange with a market cap of $8.05 billion.
With Automation Market Maker, Uniswap assures that high-volume trades have enough liquidity. It let users earn incentives by becoming liquidity pool providers. Uniswap is 100 percent anonymous. All you need is an Ethereum wallet to swap any ERC-20 tokens except Fiat-Crypto trade. Moreover, it gives you full control of your private keys.