What Is DeFi?
What Is Decentralized Finance (DeFi)?
Welcome back, the next cryptocurrency fundamental we will learn is called Decentralized Finance or DeFi for short. In my opinion DeFi is one of the most disruptive technologies on the planet right beside Bitcoin, because we now have the ability to tokenize every single Derivative on the planet from Commodities, Bonds, Currencies and many others. Our world is heading toward massive change and when humanity wises up to the alternative financial markets we will never be the same.
To put this in perspective, according to the Bank of International Settlements the total value of the derivative market is an estimate 600 Trillion dollars. Now compare that to the total value of the Cryptocurrency Market, at the moment is stands at 1 Trillion USD, that's less than 1% of the 600 Trillion dollar derivative market.
Now image how much the Cryptocurrency market will be worth when the shift to DeFi takes place, if just 1% of that market moves into DeFi that's will be a 600% move at just 1% of the derivative market. This is called wealth transfer, this is the real Great Reset we keep hearing about. The problem is if you miss it you will have to eat the bugs. Because the shift will disrupt supply-chains, food production, product production and banking. Now think about this in relation to DeFi. How much of the 600 Trillion market do you think will flow into DeFi? This is why it's vital to learn about it because our financial future is taking shape now. Okay to better understand this market here is the definition of DeFi from Investopedia.
The definition of DeFi states:
Decentralized finance (DeFi) is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. In the U.S., the Federal Reserve and Securities and Exchange Commission (SEC) define the rules for centralized financial institutions like banks and brokerages, which consumers rely on to access capital and financial services directly. DeFi challenges this centralized financial system by empowering individuals with peer-to-peer digital exchanges. DeFi eliminates the fees that banks and other financial companies charge for using their services. Individuals hold money in a secure digital wallet, can transfer funds in minutes, and anyone with an internet connection can use DeFi. - Investopedia
This definition is okay but it falls short on the actuall power of DeFi it's more than just a peer-to-peer peer-to-peer digital exchanges and it dose far more than eliminate fees.
Here is a brief history of DeFi.
Yes, one could point to the launch of Bitcoin in 2009 as the beginning of the DeFi movement. This is true insofar as Bitcoin was responsible for the rise of cryptocurrencies more broadly as an industry. Bitcoin popularized the idea of decentralized tokens and related services like exchanges. However, the Bitcoin ecosystem is not built to enable DeFi protocols.
For those of you unfamiliar with the Blockchain wars back in 2017 the problem was with certain developers that wanted to change the bitcoin protocol to allow larger block sizes, however if you expand the Block size it would weaken security(so were some of the claims). Which is why we have Bitcoin Cash and other Bitcoin Alt coins.
However, the Bitcoin ecosystem is not built to enable DeFi protocols. Those rely instead on Ethereum (which was of course also indebted to Bitcoin for its own existence). One of the key developments of Ethereum was the use of smart contracts which allow developers to create a wide variety of decentralized apps, including those related to DeFi. To this day, most DeFi protocols exist in the Ethereum ecosystem. Notably, the concepts of some of the most well-known DeFi protocols, such as MakerDAO, predate the launch of Ethereum. Maker is a lending protocol that allows users to borrow cryptocurrencies instantaneously, or to earn interest from lending out crypto tokens, and it also provides its own stable-coin. Maker was created in 2014, though it officially launched in 2017.
For those of you who would like a deeper dive into this history I provided the link here, we will also speak on Stable-Coins as we progress in later topics. MakerDAO is a decentralized smart contract that use the DAI stable-coin for Overcollateralization.
https://decrypt.co/resources/a-brief-history-of-defi-learn
The definition of Decentralized Finance states:
Decentralized finance eliminates intermediaries by allowing people, merchants, and businesses to conduct financial transactions through emerging technology. Through peer-to-peer financial networks, DeFi uses security protocols, connectivity, software, and hardware advancements. Wherever there is an internet connection, individuals can lend, trade, and borrow using software that records and verifies financial actions in distributed financial databases. A distributed database is accessible across various locations as it collects and aggregates data from all users and uses a consensus mechanism to verify it.
Decentralized finance eliminates the need for a centralized finance model by enabling anyone to use financial services anywhere regardless of who or where they are. DeFi applications give users more control over their money through personal wallets and trading services that cater to individuals. - Investopedia
Okay now before I move to the Smart Contract I would like to highlight a few points. Back in 2017 – 2018 the SEC started to crack down on all the exchanges in the Cryptocurrencies market. They forced (KYC) Know Your Customer laws and gave heavy fines to centralized exchange that did not comply. Out of this created the need for DeFi. This is why “Decentralized finance eliminates the need for a centralized finance model by enabling anyone to use financial services anywhere regardless of who or where they are.” No one person created the concept of decentralized finance It was part of an evolutionary process out of necessity with the help of what is called the Smart Contract.
The definition of Smart Contract states:
It's computer code that acts as a digital agreement between two parties. A smart contract runs on a blockchain and is stored on a public database, and can't be altered. Because the blockchain processes smart contracts, they can be sent automatically without a third party. The peer-to-peer transaction is closed only when the conditions in the agreement are met.
Now this right here is the game changer, computer code that can't be altered which acts as a digital agreement between two parties automatically. This is why the Banking Cartel fear Cryptocurrencies, because it makes them obsolete.
The obvious benefit of smart contracts is that they can be created for you to borrow and lend your cryptocurrency without the use of an intermediary, which sidesteps a lot of the risks involved in traditional lending. If, for example, a borrower can't meet their obligations in a loan, their lender can simply take their funds back, making the need for collateral unnecessary. What's more, DeFi saving accounts could function in the same way as savings accounts at banks but might offer higher interest rates or could pay out either daily, weekly or monthly, depending on the platform.
Most of the DeFi platforms are built on the Ethereum Blockchain, the world’s second-largest cryptocurrency, a Blockchain platform that allows developers to build Decentralized Apps. Adding on the features of Bitcoin Blockchain like Decentralization, Distributed Ledger System, and Immutability, Ethereum also has Smart Contracts i.e., an agreement that is fulfilled only when all conditions are met. Smart contracts on the Blockchain aid in facilitating services apart from just storing and sending value. Smart contracts assist in making digital money programmable. You must wonder ‘how can money be programmable? It’s not a software…’ but logic can be programmed into payments thus allowing not just the control of your digital money but also services that are only provided through Financial institutions like lending and borrowing a loan or trading in derivatives.
DeFi eliminates the role of third parties in any financial transaction over the Blockchain thus saving a lot in fees, commissions and brokerages.
Okay I wanted to read this article from Coinjournal.net to reiterate the power and purpose of Defi. The Decentralized Distributed Ledgers are distributed by decentralized Apps using Immutability via the Smart Contracts. With the Smart Contracts you can Lend, Borrow and even trade derivatives without fees or commission going to brokerages. Now keep in mind the derivative market is worth 600 Trillion dollars. Can you see the big picture?
The attributes of DeFi are as followed:
1. Decentralized
The biggest advantage and most important trait of DeFi is complete control over your Digital Assets. In traditional financial institutions, the bank is custodial of all your finances and is free to do whatever it decides with your funds. DeFi eliminates the involvement of intermediaries thus being cost-effective. There are also no geographical barriers or monetary limitations for entering the DeFi realm.
2. Permission-less
Anyone can enter the world of DeFi, unlike traditional financial institutions no prior approval or permission is required for access. Instead, DeFi follows a free, open, and permissionless model thus providing the people unable to do financial activities through traditional mediums the freedom of accessing those financial services through DeFi. Anyone with internet access and a crypto wallet has access to DeFi. The DeFi platform has no cross-border barriers thus allowing anyone from any place with any amount of money to be a part of DeFi.
3. Distributed Ledger
The distributed ledger system will make all the transactions on the DeFi platform transparent as everyone on the network will have a copy of the transaction. All the members of the Ethereum Blockchain network will also have to verify these transactions. Ethereum addresses are encrypted keys thus making the identity of the members anonymous.
4. Interoperability
Opportunities on DeFi are interoperable, deeper you dive into the DeFi world the more services you’d want to access. New DeFi applications and interfaces are developed to work interoperably with different blockchains and different applications for specific use cases. Third-party applications can also be integrated with the existing protocols and applications.
5. Immutability
As everyone can be a part of the DeFi realm, it is of utmost importance that financial transactions are not tampered with. Since the risk of fraud is always high with regards to financial activities, the immutability characteristic of the Blockchain provides security and maintains the data integrity of DeFi activities.
6. Programmability
As most of the DeFi applications are based on the Ethereum Blockchain, smart contracts can be programmed and used in the automatic execution of financial activities which will also pathways for creating new financial service use cases and financial instruments. Thus making the DeFi realm as equipped as any traditional financial system.
https://coinjournal.net/learn/what-is-defi/
Use Cases of DeFi
https://www.dapp.com/dapps/blockchain-games
Gaming and eSports
With the use of DeFi, game developers can implement the newer incentive or reward models with DeFi coins. In fact, gaming and eSports will likely become one of the major markets as the users are more tech-savvy and open to newer technologies. /101 - Blockchain
Borrowing and Lending
DeFi, or Decentralized Finance, is an ecosystem of financial apps developed on top of blockchain networks, particularly the Ethereum blockchain, that run without the involvement of a third party or central administration./AMMAG- In Touch with Tomorrow
DeFi lending, in which a user deposits funds into a protocol, is similar to a typical cash deposit or investment that earns interest over time. These rates, however, are highly appealing to high-capital investors, hedge funds, or institutions, mainly when applied to stablecoins like USDT, USDC, or DAI. Lending can also assist in lessening the risks of market volatility because consumers make money without trading.
Decentralized protocols do not require authorization to utilize. As a result, its services cannot be based on traditional evaluations such as credit score, equity, or income to calculate a safe loan amount. On the other hand, lending sites demand borrowers to put up crypto assets as collateral. DeFi loans are always excessively collateralized. /cryptonewsme.com
Asset Management
Many of the top DeFi projects are offering solutions that allow the users to manage their assets, including — buying, selling, and transferring digital assets. Thus, the users can even earn interest from their digital assets too. On contrary with the traditional financial system, DeFi allows the users to maintain the privacy of their sensitive data. Think of the private keys or passwords for your financial accounts — you had to share that information with relevant organizations earlier. Now, different DeFi projects, like Metamask, Argent, or Gnosis Safe are helping the users to encrypt and store those pieces of information on their personal devices. This ensures that only the users have the access to their accounts and can manage their assets. So, asset management is one of the most practical decentralized finance uses cases to the users. / 101 Blockchain
Predictive Markets
prediction platforms and the market are very large and attract many users. The rise and use of DeFi, has created an opportunity to develop DeFi-based prediction platforms where users could trade value by forecasting or predicting the outcome of future events. These prediction platforms are peer-to-peer, decentralized, and offer global access. Augur is one of the leaders in the DeFi ecosystem that specialize in the prediction market. This platform allows the users to place bets on events like — sports, world events, economics, election results, and more. /101 Blockchain
Stablecoins
Because Cryptocurrencies are highly volatile assets that gain or lose value within seconds. This is one of the major reasons why cryptocurrencies are yet to achieve mass adoption. A stablecoin is a special type of cryptocurrency that is asset-backed. The pool of assets includes but is not limited to — fiat currencies, gold, oil, commodities, and other cryptocurrencies. /101-Blockchain
Decentralized Exchange
Trading and Exchange: Decentralized exchanges (DEXs) provide a secure and transparent platform for users to trade cryptocurrencies without the need for intermediaries. DEXs are also more resistant to hacks and provide users with more control over their assets.
Decentralized exchanges are an alternative; they cut out the middle man, generating what is often thought of as a "trustless" environment. These types of exchanges function as peer-to-peer exchanges. Assets are never held by an escrow service, and transactions are done entirely based on smart contracts and atomic swaps.
The crucial difference between centralized and decentralized exchanges is whether or not a middle man is present. Decentralized exchanges are less widespread and less popular as compared with centralized exchanges. Nonetheless, there are more decentralized exchanges all the time, and it's possible that they will give centralized exchanges a run for their money in the future./Investopedia
Decentralized Autonomous Organizations
A decentralized autonomous organization (DAO) is an emerging form of legal structure that has no central governing body and whose members share a common goal to act in the best interest of the entity. Popularized through cryptocurrency enthusiasts and blockchain technology, DAOs are used to make decisions in a bottom-up management approach. /Investopedia
Analytics and Risk Management Tool
Transparency and decentralization paved the way to discover and analyze an unprecedented amount of data for the users. With the access to these data, users can make well-informed business decisions, discover new financial opportunities, and adopt better risk management tactics.
A new breed of data analytics with useful blockchain tools and dashboards has emerged from this industry trend. DeFi projects like DeFi Pulse or CoDeFi Data are bringing an impressive amount of value with analytics and risk management tool.
Now, businesses have become more agile as they are enjoying unforeseen competitive advantages. This is surely one of the more impacting decentralized finance use cases./101 Blockchain
Additional Resources:
https://nasacademy.com/blog/article/what-is-defi-and-its-top-use-cases-2
https://www.blockchain-council.org/defi/defi-protocols/
https://coinjournal.net/learn/what-is-defi/
https://decrypt.co/resources/a-brief-history-of-defi-learn
https://www.linkedin.com/pulse/top-5-use-cases-decentralized-finance-defi-blockchain-ammag-tech/
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