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Decentralized Finance (Decentralized Finance (DeFi) is a term that is being used to describe the world of financial services that are increasingly... More) are financial services built on blockchain technology. It seeks to empower the populace by creating an open, efficient, and all-inclusive financial system. Using smart contracts, DeFi platforms provide permissionless finance, thus enabling financial inclusion for all. DeFi has taken off to include many meaningful use cases. These include Cryptocurrencies are on their way to global penetration, as their prominence continues to grow, and people find more use for... More, lending platforms, prediction markets, and others.
It takes out the middleman and replaces it with smart contracts—which creates trustless protocols. Smart contracts are self-executing contracts that act out a programmed agreement between a buyer and a seller. With the removal of intermediaries, DeFi offers access to financial services, particularly to those unbanked by the current systems.
In this guide we will cover the following:
It’s easy to confuse DeFi with Fintech. Both work via the Internet, and they provide financial services without the need to deal with banks or traditional financial institutions. However, they differ on some fundamental levels.
One of the prominent differences is that while Fintech puts the traditional financial infrastructure on the Internet, DeFi is built solely on the blockchain technology into the mix.
FinTech juggernaut Square, is a payment processor that offers faster and cheaper cross-border payments than traditional banks. However, Square’s platform still involves a central authority – Square itself. The company completes transactions on behalf of its customers, and they also require the provision of a valid identification before opening accounts.
DeFi, on the other hand, differs. Stablecoins are a class of cryptocurrency that aims to provide price stability. A perceived drawback of cryptocurrency is price volatility.... More with a value pegged to the dollar. Anyone transacting with this currency doesn’t need to trust any organization to complete transactions. Instead, transactions are validated by Blockchain is a digital ledger that’s used for storing data on several servers across the world in a decentralized, trustless... More miners on the blockchain. This is done regardless of race or nationality.is an -based
This is perhaps the most significant use case for DeFi. Lending and borrowing platforms provide loans to users without the need for intermediaries like BlockFi. There are also lending protocols in place that pays users interest in stablecoins and cryptocurrencies.
For now, theand Ethereum blockchains are the most popular ones for DeFi lending and borrowing. Some of the most popular lending and borrowing platforms in this racket include Dharma, Compound., and BlockFi.
DeFi asset management tools act as asset custodians, but aren’t engaged in any banking or commercial services. In DeFi, asset management tools provide wallets apps and other tools that help crypto holders to effectively manage their assets.
New investors might find it difficult to set up wallets or making their way around the space (including diversifying their investments, finding exchanges, etc.), but asset management tools help take out any complexity.
A derivative is a contract between two or more parties that depends on the performance of an underlying asset to get its value.
DeFi derivatives are very flexible, as their inherent smart contracts can issue tokenized derivatives contracts that are executed automatically. Generally, derivatives are used to safeguard investors from price fluctuations, and to speculate on the performance of an asset in the future. Some examples of DeFi derivatives platforms include:
Synthetix operates as a multi-tier exchange and issuance platform that allows users to mint various assets – including cryptocurrencies, fiat currencies, and derivatives. With its Synths tokens, users are able to make investments in some top assets (including, gold, and the dollar) and stocks (including Apple, Tesla, etc.) within the Ethereum blockchain.
A user invests collateral in the form of the Synths token and creates a synthetic asset. From there, they can exchange or swap one asset for another. The process is independent of any counterparties too.
Crypto insurance remains one of the most sought-after concepts in the cryptocurrency space. Investors will like to have platforms that can help them insure their private keys and digital assets, especially in the face of exchange hacks, Once you've bought or received bitcoins; you now need to keep them as safe as possible. This guide will provide... More breaches, carelessness on their part, and fund mismanagement.
DeFi insurance protocols make it possible for users to take out insurance policies on smart contracts and digital assets by pooling funds to cover individual claims. Admittedly, the DeFi insurance market is small. However, as the market grows, players are set to grow as well.
A popular player in this space is Nexus Mutual – an Ethereum-based decentralized insurance protocol that allows anyone to buy insurance coverage or contribute capital to help cover a claim through a risk-sharing protocol. Members own the insurance pool, and participation is done by contributing Ether into the pool in exchange for its native NXM token. However, the fund will need to have at least 12,000 ETH before insurance claims can be processed.
DeFi transactions aren’t dependent on human intermediaries. However, there’s still a risk to smart contracts themselves. Inherently, smart contracts are open-sourced. This means that others can review them. Reviews can give smart contract users some peace of mind; there’s still a risk that someone could have missed something important, thus resulting in a terrible operational error.
The DAO, one of the biggest crypto crowdfunding projects ever, was affected after hackers exploited a vulnerability in its open-source code. The vulnerability allowed them to steal about a third of the funds raised.
One of the most significant limits to a blockchain’s operation is its inability to access off-chain data. They help compensate for this with Oracles, which gives access to important external data. With Oracles, smart contracts can take information from the outside world and make changes based on that.
However, when the Oracle provides the wrong information, it could be catastrophic. Wrong information could arise intentionally or not, but they do happen. The Oracle used by Synthetix once submitted false data. A bot used by one of the platform’s owners caught this, and the lucky owner was able to make over $1 billion in profits in less than an hour.
The permissionless nature of DeFi loans is laudable. However, when compared to traditional finance, they’re still markedly capital-inefficient, as the loans you can get relative to collateral isn’t as favorable as what you could get with traditional loans.