What is DeFi

The ecosystem behind Decentralized Finance explained simply

It’s been on everyone’s lips for quite some time now, and it reflects the idea of decentralization better than pretty much anything that came before it. We are talking about Decentralized Finance or called DeFi for short. It’s an idea on which big-name projects such as the decentralized lending platform MakerDAO are already built and celebrate great success. But there is so much more behind DeFi. It’s an entire ecosystem. Credit protocols, security coins, stablecoins, derivatives, exchanges, and much more adorn the wonderful world of DeFi. Sound interesting? Then wait and see because DeFi has so much more to offer.

In this article, we will clarify the most important question of all: what is DeFi? Then, we’ll introduce you to the vision behind it all. We will explain what DeFi is all about and which promising projects are already working on it at full speed. As always, it’s worth staying tuned because this will be not only educational but also exciting.

What is DeFi?

DeFi is essentially just a conventional financial instrument built on a blockchain. Primarily, the Ethereum blockchain is used for this purpose. DeFi applications are mostly based on open-source protocols for creating and issuing digital assets. Their advantage, among others, is that they are designed to offer notable benefits of operating on a public blockchain, such as censorship resistance and improved access to financial services. In this way, the DeFi movement addresses an important core criterion of cryptocurrencies, and that is the promise of making money and its transaction universally accessible. And that is for every person, no matter where he or she lives in the world.

The DeFi movement takes this promise even a step further. It aims to provide a global, open alternative to every financial service available today. These include the ability

• ·        to save,
• ·        take out loans,
• ·        trade,
• ·        take out insurance

and much more. All that is needed is a smartphone or computer with an internet connection.

This makes it possible to use smart contracts. Those who have already read our knowledge article about Ethereum already know that smart contracts are self-executing contracts. These make it possible to develop far more sophisticated functions than simply automating the sending and receiving of cryptocurrencies. Such decentralized applications are called dApps.

·        In the context of DeFi, dApps already exist that can

1. ·        The creation of stablecoins,
2. ·        the completion of a credit transaction
3. ·        executing automated advanced investment strategies.

·        What makes DeFi different from the traditional financial system?

The key question, of course, is why use these DeFi-dApps at all? After all, traditional banking or Wall Street counterparts already exist for all of these products mentioned. Unfortunately, this is only true in certain parts of the world. There is also the following difference. At their core, dApps and their associated business processes are not managed by a company, institution, or individual. Instead, the processes are automatic, and the associated rules are hardcoded in the smart contract. There, they are visible to all and transparently represented in the form of code.

Once the smart contract is implemented on the blockchain, it can execute itself with little or no human intervention. DeFi-dApps are thus visible to everyone but pseudonymous. They cannot be directly assigned to the real identity of the user. DeFi-dApps can be used from anywhere in the world where an internet connection is available. They are censorship-resistant and, thanks to the automated execution of the smart contracts and the visible code, conclude contracts and/or their use trustworthy and transparent, even without intermediaries.

Not without reason, DeFi is currently one of the fastest-growing sectors in the crypto field. More than $600 million worth of cryptocurrencies have already been invested in smart contracts in question, and thus in infrastructure. What exactly are some of the most important and popular use cases and projects in the DeFi sector, let’s take a closer look now.

1. open credit protocols — accessible to everyone

Open credit protocols have probably attracted more attention recently than any other category in the field of DeFi on Ethereum. Largely due to the meteoric rise in Dai's use and other P2P protocols like Dharma and the creation of liquidity pools like Compound Finance, decentralized lending is garnering powerful attention, and rightfully so. Open, decentralized lending offers numerous advantages over traditional lending structures. It enables

1. ·       The integration of lending/borrowing of digital assets,
2. ·        the insurance of digital assets,
3. ·        instant transaction processing and new methods of secured lending,
4. ·        broader access to people who are unable to access traditional services
5. ·        standardization and interoperability, which can reduce costs through automation.

Secured lending using open protocols such as MakerDAO and Dharma are designed to minimize the need for trust. They achieve this by making use of the functionality of Ethereum-based smart contracts. Open protocol lending is entirely confined to the public blockchain and has some intriguing long-term implications for expanding financial inclusion worldwide. MakerDAO is the most well-known decentralized lending protocol.

2. issuance platforms and investment

Issuing platforms encompass a wide range of platforms, including multiple exchanges that simultaneously serve as issuing media. A significant portion of issuance platforms are in the security token space.

Well-known security token issuance platforms such as Polymath and Harbor provide issuers with the framework, tools, and resources to launch security tokens on a blockchain. They are preparing their own standardized token contracts for securities (i.e., ST-20 and R-Tokens) that allow for automated compliance and customizable trading parameters to meet regulatory requirements. Besides, they are similarly integrated with service providers such as broker-dealers, legal entities, and others to assist issuers in their process. Dual exchange/issuance platforms include Overstock’s tZERO, for example.

Issuance platforms and investment management systems are likely to grow rapidly in importance as more participants enter the open finance world while providing growth for the DeFi ecosystem.

 

3. decentralized betting platforms

Decentralized betting platforms are among the more compelling components of open finance that are highly complex but offer tremendous potential. Augur launched a censorship-resistant platform based on Ethereum last year that allows people to bet on just about anything. Other projects, such as Gnosis, are aiming for something similar.

Betting platforms, or prediction markets, have long been popular financial tools for hedging risk and speculating worldwide events. Decentralized prediction markets enable the same thing, but with cryptocurrencies and without the ability to censor the markets. Everything from political and weather forecasts to hedging all kinds of risks on financial or adverse events in the real world is already offered in Augur.

4. exchanges and open marketplaces

The role of exchanges is fulfilled by decentralized exchanges (DEX). A DEX is a P2P marketplace for assets on Ethereum between two parties, where no third party acts as an intermediary in a transaction. Thus, they differ from centralized exchanges like Coinbase & Co. in this respect. Some DEX also uses some highly innovative methods of exchanging tokens such as atomic swaps and other non-depository means of exchanging one asset for another with minimal settlement time and risk.

Other types of open marketplaces focus on exchanging non-fungible tokens (NFTs), often referred to as crypto-collectibles. Platforms such as OpenSea and Rarebits facilitate the search and buy/sell of crypto assets ranging from NFTs in games such as Cryptokitties to virtual land parcels in the game Decentraland. Some marketplaces, such as District0X, are even said to allow users to create their own exchanges and vote on management procedures. Current examples of dexs that offer cryptocurrency trading include Binance DEX and Ether Delta.­

5. stablecoins

Stablecoins now come in a wide variety of models. They differ in part in how they issue coins, how their reserves are checked, and the mechanism for fixing their price. Stablecoins are tokens issued by a blockchain that are intended to maintain a stable value. There usually is a peg to an external asset such as USD, gold, or others to achieve this. Roughly, the following 3 categories can be distinguished in stablecoins:

• 1.      Crypto collateralized
• 2.      Fiat collateralized
• 3.      Non-collateralized

Crypto collateralized stable coins include Maker’s Dai. Fiat-backed stablecoins, however, are by far the most popular stablecoins on the market. First and foremost is Tether, although there are now numerous alternatives. The models for these stablecoins do not differ much from each other. With all of them, users have to trust the providers. Some offer regular and voluntary audits to create the necessary trust through transparency.

Unsecured stablecoins are neither centralized nor backed by crypto assets. They are built on an algorithm to maintain a stable value. To put it simply, the algorithm considers supply and demand as parameters and adjusts them accordingly, always to keep them in a balanced ratio. The basis was the pioneer in this category but failed due to regulatory concerns. As a result, the project was scrapped.

The future of DeFi — potential or all hype?

The final question, of course, is how great the potential of the whole DeFi movement is? Basically, it can be stated that there are many things in the field of cryptocurrencies that are simply overhyped. The immeasurable potential is attributed to the vision so that the actual product has no chance at all to live up to the exaggerated expectations. What follows is severe disillusionment and disinterest. However, with DeFi, it is a bit different because there are already some finished products like MakerDao, and the market has received them well.

Nevertheless, we are still in a very early phase of the whole DeFi movement. However, the potential behind it is huge. Even if only one spate of DeFi, such as Lending, were to succeed in the future, that is already more than enough. If the DeFi ecosystem can offer loans at better conditions than most national banks and other lending institutions, this could lead to global adoption.

But this is also where we are already at one of the biggest hurdles that the DeFi sector still has to overcome. For one thing, more education is needed so that the masses even know that this alternative exists. As before, only a tiny percentage is even concerned with the issues surrounding cryptocurrencies and blockchain technology. Even fewer deal with the DeFi sector in particular or have even heard of it. On the other hand, the user-friendliness of such products must be improved enormously to set the necessary course for the broad masses to use it and for global adoption to take place.