What is DeFi?
DeFi stands for “decentralized finance” and refers to financial products and services available to anyone who can use blockchain technologies that provide decentralized finance solutions, such as Ethereum, Solana, or Avalanche – meaning anyone with an internet connection. Markets are always open with DeFi, and no centralized authorities can block payments or deny you access. Services that used to be slow and prone to mistakes made by humans are now automated and safer because they are run by code that anyone can look at and check.
There is a thriving crypto economy where you can borrow, go long/short, earn interest, and do other things. Argentina’s crypto-savvy citizens have used DeFi to avoid crippling inflation. Companies have begun to stream their employees’ pay in real time. Some people have even taken out and paid off multi-million-dollar loans without providing any personal identification.
Centralized Finance (CeFi)
Today, centralized systems run by governing bodies and gatekeepers manage almost every aspect of banking, lending, and trading. Regular consumers must deal with financial intermediaries to get auto loans, mortgages, stocks, and bonds.
In the U.S., the Federal Reserve and SEC set the rules for centralized financial institutions and brokerages, and Congress amends them over time. Consumers can only directly access capital and financial services. They must avoid banks, exchanges, and lenders, who profit from financial transactions. All players must pay.
Decentralized Finance (DeFi)
DeFi challenges the centralized financial system by empowering people through peer-to-peer exchanges. TrustToken CEO Rafael Cosman says decentralized finance unbundles traditional finance. DeFi puts lending, borrowing, and trading in the hands of regular people. How could it go? Today, you can save online and earn 0.50% interest. The bank lends the money to another customer with 3% interest and keeps 2.5%. On DeFi network, users lend their money directly to others, avoiding a 2.5% profit loss and earning 3% interest. You may think, “I already do this with PayPal, Venmo, or CashApp.” Nope. Peer-to-peer payments still rely on centralized financial intermediaries because you need a debit card or bank account to send funds.
Blockchain powers DeFi
Blockchain and crypto enable decentralized finance. Your conventional checking account transactions are recorded in a private ledger owned and managed by a large financial institution. Blockchain is a decentralized, distributed public ledger that records financial transactions. All sides that use a DeFi application have an identical copy of the public ledger, which records every transaction in encrypted code. This secures the system by giving users anonymity, payment verification, and a (nearly) unchangeable record of asset ownership. Decentralized means there is no intermediary or gatekeeper. Solving complex math problems and adding new blocks of transactions verifies and records transactions by parties using the identical Blockchain.
DeFi provides services without intermediaries using cryptocurrencies and smart contracts. Financial institutions today guarantee transactions. Your money goes through them, giving them power. Billion people can’t access a bank account. Smart contracts replace banks in DeFi transactions. Smart contracts are Ethereum accounts that can send/refund funds based on criteria. Live smart contracts can’t be changed; they always execute as programmed. A contract could transfer money from Account A to Account B weekly if Account A has sufficient funds. No one can alter the contract to steal from Account C.
Anyone can inspect and audit contracts. Bad contracts are scrutinized promptly. This implies trusting the Ethereum community’s code-reading experts. Open-source communities help monitor developers. This need will fade when smart contracts become easier to read and better means to verify code are created.
DeFi Vs. CeFi
Understanding today’s difficulties in traditional finance can help you see DeFi’s potential.
- Some can’t open bank accounts or use financial services.
- Unemployment might result from a lack of financial services.
- Financial services can prevent payment.
- Financial services charge for personal data.
- Centralized institutions and governments can close markets.
- Trading hours are generally based on time zone.
- Internal human processes slow money transfers.
- Intermediaries charge a premium for financial services.
Popular blockchain platforms for DeFi Development
The majority of DeFi dApps are built on the Ethereum platform. But as DeFi plays a more significant role in shaping the finance industry’s future, almost every new blockchain protocol is growing its DeFi ecosystem. The architecture of new-age blockchain protocols such as Solana, Cardano, and Polygon supports the development of new breeds of automated and decentralized financial dApps/services powered by smart contracts and can eliminate traditional intermediaries such as banks.
Below, we will look at some of the best blockchain platforms for DeFi development, such as:
Solana is a significant blockchain network that aims to boost decentralized finance’s speed, scalability, and low fees. Many new DeFi projects have emerged on Solana, further expanding its DeFi ecosystem. But because using DeFi on Ethereum is so expensive, much of the DeFi market share has moved to layer one chains like Solana.
Solana is a perfect fit for a DeFi-focused chain. Fast block times and the Proof-of-History consensus mechanism prevent front running. Because of its node scalability, it avoids congestion and keeps transaction costs low. Solana is well on its way to developing a thriving DeFi ecosystem. All DeFi projects, such as asset management tools, decentralized exchanges, margin trading, and decentralized lending, are being developed on Solana to become its DeFi blue chips.
At the bottom of Polkadot’s ecosystem is the Polkadot relay chain, and at the first level is the network of parachains. Parachains are heterogeneous blockchains built on top of Polkadot. DeFi projects are being developed on the native Polkadot chain and the parachains. Polkadot has many powerful features to help DeFi projects, the most notable of which is interoperability. Polkadot uses cross-chain message passing (XCMP) to ensure that parachains and the DeFi projects built on them can talk and work together better. DeFi, built on Ethereum and Bitcoin, can communicate with the Polkadot ecosystem via bridges.
Polkadot is fundamentally about interoperability. It’s a multi-tiered chain network. The relay chain governs the consensus mechanism and shared security for all layer one chains, known as parachains and paraheads, and is located at the base layer. The economic security provided by the validators of Relay Chain benefits all parachains connected to the Polkadot Relay Chain.
Cardano launched smart contracts, opening its ecosystem to a slew of promising dApps. Developers are already flocking to Cardano to use its new smart contract functionality to create exciting dApps projects. Cardano was established in 2015. Its goal was to create a network that addresses the shortcomings of first and second-generation blockchains in terms of interoperability and scalability. Cardano wants to be the most reliable platform for building safe, scalable decentralized apps that can be used in the real world. It aims to give economic identity to billions of people through decentralized applications that help manage identity, value, and government.
Polygon is another blockchain making a name for itself as a DeFi platform on the rise. Polygon, which used to be called MATIC, has overgrown in 2021 and seems to be getting ready to compete with the most prominent blockchains for a more significant share of the DeFi ecosystem. The total gross value locked (TVL) in the Polygon smart contracts that run DeFi protocols has grown by no less than 4,178,708%, which is an exponential increase.
Polygon’s success can be attributed to the network’s fast and cheap transactions. Running a Defi dApp on Polygon is hundreds of times more affordable than on larger networks like Ethereum. It is also more efficient in terms of time. Polygon is used by major and popular DeFi platforms such as SushiSwap (CRYPTO: SUSHI), Aave (CRYPTO: AAVE), 1inch (CRYPTO: 1INCH), Curve (CRYPTO: CRV), and others. Ethereum is still the undisputed home of DeFi in the crypto space. However, users are looking for alternative protocols as the Ethereum network experiences high traffic and becomes slow and expensive. Polygon is a popular choice among these developers because it is a cheaper and faster version of Ethereum that can be used to build and connect blockchain networks and applications that work with Ethereum.
Another blockchain network benefiting from positive DeFi sentiments is Avalanche (AVAX). It is a blockchain platform with smart contracts focusing on low costs, transaction speed, and environmental friendliness. Avalanche is one of the most powerful, open, and programmable smart contract platforms for developing solutions for DeFi, debt financing, asset issuance, and digital collectibles.
Avalanche works with Ethereum’s assets, apps, and tools, and it speeds up transactions, reduces fees, and increases throughput. Avalanche is also building a bridge to connect with the Ethereum network to facilitate the seamless transfer of assets. SushiSwap, Reef, TrueUSD, bZx, and Securitize are among the DeFi projects integrated into the Avalanche blockchain.
Finality is essential to the Avalanche protocol, especially when building decentralized financial applications. While Ethereum takes about a minute to reach finality, Avalanche takes only one second.
DeFi’s Important Usages
Most financial services can also be executed in a decentralized form. But Ethereum also gives people a chance to make entirely new financial products. Here are only a few of the many usages listed:
Transferring money around the world
As a blockchain, Ethereum is designed to securely send transactions around the world. Like Bitcoin, Ethereum makes it as easy to send money worldwide as it is to send an email. Enter your recipient’s ENS name (such as bob. eth) or account address from your wallet, and your money will be sent directly to them within minutes (usually). You will need a wallet if you wish to transfer or receive cash.
The volatility of cryptocurrencies makes it hard to use many financial products and spend money in general. Stablecoins were the answer that the DeFi community came up with. Their value is tied to something else, usually a well-known currency like the dollar.
The value of coins like the Dai or USDC stays within a few cents of a dollar. Because of this, they are great for earning or selling. In Latin America, many people used stablecoins to protect their savings when their government-issued currencies were unstable.
Borrowing money with a collateral
There are two major forms of borrowing money from decentralized providers.
- Peer-to-peer means that a borrower takes out a loan directly from a lender.
- Pool-based lenders put money (liquidity) into a pool borrowers can borrow. Using a decentralized lender has many advantages.
Borrowing money without a collateral
Money lending and borrowing are all about the people involved. Before giving you a loan, banks need to know if you will likely pay it back.
When decentralized lending is used, neither party has to reveal who they are. Instead, a person who wants to borrow money must provide collateral that the lender will take if the loan is not repaid. Some lenders will accept NFTs as collateral. NFTs are the title to a singular object, such as a painting. This allows you to borrow money without a credit check or personal information disclosure.
The goal of decentralized insurance is to make it cheaper, faster to pay out, and more evident. With more automation, coverage costs less, and claims are paid out much quicker. The information used to decide on your claim is clear to everyone. Ethereum products can have bugs and be poorly used like any other software. So, many insurance products are currently made to protect people from losing money. But projects are beginning to cover everything that life can throw at us.
According to Coinbase, A decentralized exchange (a DEX) is a peer-to-peer marketplace where transactions occur directly between crypto traders. One of the essential things that DEXs do is help people make financial transactions that don’t involve banks, brokers, payment processors, or any other kind of middleman. The most popular DEXs, like Uniswap and Sushiswap, utilize the Ethereum blockchain and are part of the growing suite of decentralized finance (DeFi) tools, which make a massive range of financial services available directly from a compatible crypto wallet. DEXs are booming — in the first quarter of 2021, $217 billion in transactions flowed through decentralized exchanges. As of April 2021, there were more than two million DeFi traders, a ten-fold increase from May 2020.
Managing your portfolio
You’ll need a way to track all your loans, investments, and trades. Thanks to several products, you can track everything you do with DeFi from one place. That’s why DeFi’s open architecture is so great. Teams can make interfaces that let you see how much money you have in each product and use its features.
Crowdfunding is a fantastic way to use Ethereum or other. Ethereum and its tokens are accessible to everyone, anywhere in the world. Potential funders can come from anywhere, and it’s easy to see how much money has been raised. You can even see how the money was spent in the future. The Fundraisers can set up automatic refunds if, for example, a deadline and minimum amount aren’t reached.
The Potential for DeFi
DeFi’s future looks promising, from cutting the middleman to converting basketball clips into digital assets with monetary value. Even though DeFi’s capabilities are still in their infancy, professionals like Dan Simerman, head of finance relations at IOTA Foundation, a DeFi research and development organization, view its promise and potential as vast. Soon, investors will have more autonomy, allowing them to “use [assets] in creative ways that are currently impossible,” according to Simerman. Simerman explains that as DeFi grows, it will enable new methods of data commodification, which has enormous consequences for the big data industry. But despite its promise, DeFi has a long way to go, particularly in public adoption.
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