Decentralized Finance or DeFi for short has been a buzzing word for almost a year now. The crypto media is stuffed with articles that reveal the ‘true’ meaning of DeFi. But what is DeFi? We’ve tried to put the DeFi definition into simple terms and provide you with examples of currently existing DeFi projects.
What is DeFi?
Decentralized Finance (DeFi) is an essential branch of the crypto industry aimed at providing decentralization to conventional financial services. To put it simply, every financial application applied to our daily lives can be moved on top of a particular blockchain to provide you with full control over your finance.
Why do we need DeFi? Let’s admit it, we lack transparency and trust in our real life, – this concerns not only the financial sector but also other governmental structures. The blockchain industry strives to provide us with these core concepts by eliminating third-party involvement in the business. And DeFi plays a vital role to bring this day closer.
There is a wide range of DeFi projects that can be used today and there are more DeFi solutions to come tomorrow. We have observed several financial sectors that have already implemented its’ products on the decentralized networks and revealed the potential of blockchain technology.
Needless to say that conventional centralized prediction markets have always been in great demand. Today, we’ve got a chance to make it open and decentralized. This sector of decentralized finance provides basic requirements. Here are three bullet points that show the advantages of P2P prediction markets over centralized ones:
- No registration is needed. Anyone from Alaska to South Africa can create or participate in the market.
- Open-source code. Unlike closed-source centralized prediction markets, peer-to-peer markets are publicly available and all transactions can be seen in the blockchain.
- Trust. Users don’t need to trust anyone but the code and themselves. There is no third party that holds your funds. You are responsible and in control of your assets.
The most recognizable P2P protocol for prediction markets is Augur – a decentralized oracle which consists of smart contracts and can be easily deployed to the Ethereum blockchain. Essentially, Augur is not a prediction market itself but an open-source software licensed by General Public License (GPL) and Massachusetts Institute of Technology (MIT) license. The main advantage of decentralized platforms for prediction markets is that they are censorship-resistant. No one in the world can control it as the code is the law. However, anyone can participate in speculation on a number of events. Augur can be applied to various sectors from weather forecasting and sports prediction to financial and political events.
DeFi projects: Augur, Gnosis, Helena
Once smart contracts were introduced, they opened a vast space for advanced solutions. If you are afraid of being robbed, you would probably insure your goods. The same technique works for the blockchain industry. There are already DeFi projects that guarantee the compensation of your loss. Such projects as Etherisc and Nexus Mutual cover your back by the power of smart contracts.
With a goal to enable lower operational costs, democratize access to reinsurance, and bring transparency to the business, Insurance decentralized applications have already entered the crypto market.
Flight Delay Insurance is the first insurance dApp launched on the Ethereum blockchain in 2016. The team of Etherisc introduced a fully-licensed application with automatic and almost instant payouts. If your flight is delayed for 45 minutes or more, the payouts will be initiated immediately once you are landed. There is no need for paperwork and bureaucracy. Just fill in the form on the website, and receive your insurance.
The team of Etherisc is also working on other important insurance dApps like Social Insurance, Collateral protection for crypto-backed loans, Crop Insurance, and Crypto Wallet Insurance. The latter is a promising project that will allow you to store your funds in a crypto wallet without worries of hacks.
DeFi projects: Etherisc, Nexus Mutual, VouchForMe
Decentralized exchanges or DEXs have been on the market for almost 3 years. Being built predominantly on top of the Ethereum blockchain (the most popular platform for a dApp deployment), decentralized exchanges provide real-time trading along with high transaction throughput just like centralized ones. Trading in a P2P way is full of advantages like lack of central authority, total transparency, availability, etc. Besides, transaction fees are usually lower compared to the centralized exchanges, as DEXs require much fewer expenses on maintenance work. When trading via DEX, a user interacts directly with smart contracts without any other entity involvement.
However, as DEXs are relatively new to the crypto industry, there are some imperfections like gas fees (for the Ethereum dApps), low trading volumes, non-friendly UX/UI, and so on. Nevertheless, the niche of decentralized exchanges is enhancing rapidly, providing opportunities for decentralized margin trading, p2p instant swaps, and many more.
DeFi projects: IDEX, EtherDelta, Oasis, Newdex, TronTrade, WhaleEx, Fulcrum, BinanceDEX.
A stablecoin is another vital entity that supports and improves the decentralized finance industry. Stablecoins are cryptocurrencies aimed to decrease the volatility of the coin’s price while providing it with stability. They can be pegged to the fiat currencies like the USD (USDT, TrueUSD), the EURO (Stasis EURO), or other exchange commodities like gold (DGX) or even BTC (imBTC).
The mechanism and importance of stablecoins in the DeFi industry are vividly demonstrated by the decentralized autonomous organization, MakerDAO, and its stablecoin DAI.
- Crypto-backed stablecoin
- Pegged to the USD
- Built on the Ethereum blockchain
- Governed by the MakerDAO system
DAI is aimed at bringing financial freedom with no volatility to everyone. You can generate the stablecoin on your terms instantly while getting an income for holding DAI.
DeFi Lending and Borrowing
Another branch of DeFi is P2P lending and borrowing platforms. Lending platforms built on a particular blockchain make both borrowing and lending faster and available to people. Users don’t need to provide thousands of papers with proofs.
One of the greatest advantages of lending marketplaces (besides lack of the third party) is that they provide an assurance of cryptographic verification methods. Decentralized lending platforms offer not only loans but also an opportunity to earn passive income.
Open Lending Protocols
Open lending protocols make truly decentralized lending possible. Such protocols as Compound, Dharma, Aave bring lending to the new level by enabling another way to get passive income – liquidity pools.
Lenders deposit their funds in a pool contract. At the same time, by placing collateral, users can borrow these funds. And here goes math as the interest rate is decided algorithmically. As a borrower takes an amount of funds from the pool, the amount of funds available in this pool decreases. Consequently, the interest rate increases. A lender’s interest rate corresponds to the earn rate which is protected by the algorithm.
DeFi projects: Compound, Dharma, Aave, NUO network
Current DeFi Challenges
To sum all of the above, DeFi meets the following challenges on the way of mass adoption.
- Optimization. Most of DeFi dApps are now built on the Ethereum blockchain that offers quite low transaction throughput. Once the scalability issue will be resolved, we can attract more users to the industry.
- Better user experience. As of now, some decentralized applications require additional skills and users can’t interact with them with ease. DApps should provide better user experience while trying to make the great transition as smooth as possible.
- Minimization of user error. Elimination of the intermediary means users should be responsible for every step they take in the DeFi space. Designing a product with native UX/UI which will minimize the risk of a user error is a core challenge for developers.
Future of DeFi
DeFi broadens horizons for financial, political and social sectors. It stands firmly at the dawn of a new era of freedom and trust but it has already provided us with an opportunity to lend/borrow, trade, use prediction market tools, get insurance in an open and transparent manner.
There are many factors that influence the decentralized finance industry mass adoption like the price of cryptocurrencies, robust and native UX/UI of dApps, and so on.
Recently published Coinbase article, claims that we are lucky to witness the inception of something important and innovative:
“Something magical is happening in the open financial system — crypto is bringing money online, and we’re seeing a quantum leap in what’s possible when it comes to the functionality of money. It’s a rare opportunity to see an entirely new industry blossom from scratch. The DeFi space will at first play catch up with today’s financial services industry. But over time, it’s hard to even fathom what innovations will come about when the power to build financial services is democratized to anyone who can write code.”
We hope this article has provided you with basic DeFi definitions and statements. While the crypto industry is gaining momentum, decentralized finance offers comprehensive services and platforms to get involved in the new crypto sphere. Get ready for the new era with stablecoins and other cryptocurrencies that can be purchased quickly via instant exchange Changelly.