Decentralized finance (DeFi) promises to revolutionize the financial market as we know it today. This new way of executing financial transactions excludes traditional institutions and intermediaries.
In DeFi, everything is conducted in a decentralized way through the blockchain. It is the users who coordinate peer-to-peer financial activities on a global scale.
Advocates claim that DeFi can do everything a bank can do, only faster, more transparently, and at a lower cost. In addition, Bitcoin has just started the decentralization revolution, providing people with a digital store of value.
Today the DeFi financial system happens through digital smart contracts on public blocks like Ethereum. According to Coingecko, the DeFi market value at around US$85 billion and represents a 5.3% share of the segment as a whole.
See everything you need to know about decentralized finance, how it works, and the advantages and disadvantages of this technology.
What is DeFi
DeFi is the name for financial services and products, such as financial sets, transfers, and payment systems, which run on a blockchain, decentralized and immutable database. Intermediaries, such as banks or other financial institutions, do not control these solutions.
Operations are reliable and smart protocols in smart contracts (computer contracts). A practical example of visualizing how one of them works is an example:
An individual can make money from another person in peer-to-peer trading. The form of transfer, amounts, interest, and prices are guaranteed by these contracts and detailed in practice by them. Therefore, there is no need to settle a bank with another entity, with its hefty fees, or to intermediate the transaction.
Therefore, the main banner of technology is to create a decentralized, independent, cheap, less bureaucratic, and accessible global financial system.
Where do DeFi applications run?
The main “home” of DeFi applications is the network, conceived by Ethereum Vitalik Buterin in 2013, and Russian annexes in July 2015. Decentralized Applications (DApps).
From there to blockchain solutions also to solutions, other solutions for decentralized development, such as Binance Smart Chain (BSC), Solana (SOL), and Avalanche (AVAX), Ethereum still concentrates the largest projects on the market despite new players.
When did DeFi come about?
The history of DeFi began to be written shortly after the announcement of the creation of the Ethereum network. In late 2014, the Danish Rune Christensen founded MakerDAO (MKR), one of the first applications to run on Ethereum. The project, a decentralized financial platform, is still active among the main representatives of this market.
However, the beginning of decentralized finance also had some mishaps, which reverberate to this day. For example, in 2016, a hacker exploited a flaw in The DAO, another pioneering DeFi application, pocketing $50 million in ETH.
After this episode, Ethereum developers will decide on the network, losing value. Not everyone, however, was in favor of this strategy, as it would go against the ideals of the project. Because of this, the network stood firm in two: on the one hand, Ethereum, today the second-largest blockchain project in the world, behind only Bitcoin (BTC); and on the other, Ethereum Classic (ETC).
In the wake of MakerDAO and the various The DAO, other decentralized finance services have come to life, such as Compound (COMP, which is also a MakerDAO funding protocol), Uniswap (UNI), a decentralized exchange (DEX), and a hundred more. Of projects.
DeFi applications
See below the main DeFi applications:
Decentralized exchanges
Like DEX, as they are called, they are exchanges where users can trade cryptocurrencies with each other (peer-to-peer) without also intermediaries. On these platforms, everything is capable by companies and smart contracts. They are different from centralized exchanges, which have a team and a company in control, as is the case with Mercado Bitcoin and Binance, for example. Two examples of DEX are a Uniswap (UNI) and a PancakeSwap (CAKE).
Evaluation platforms
It works like banking and finance and allows users to pick up cryptocurrency coins. The difference is that there are no intermediaries, and smart contracts govern everything. Overall, digital assets are needed as collateral to access resources. MakerDAO and Composite are some examples.
Stablecoins
They are cryptocurrencies paired with some assets; such as gold, silver, or fiat currencies (dollar, euro, real, and others). Two examples are Tether (USDT) and USD Coin (USDC). Each unit is equivalent to one dollar. Therefore, this asset class seeks stability and is not volatile like Bitcoin, Ethereum, and other crypto-assets.
How big is decentralized finance?
According to the DeFi protocol, a decentralized measurement site on the decentralized finance market, the Total Value Locked (TVL) on DeFi protocols reached $93 billion in early January 2022.
What are the major DeFi protocols?
The seven major DeFi protocols are as follows, according to DeFi Pulse:
MakerDAO (MKR)
It was one of the first decentralized finance projects to run on the Ethereum network. In practice, it is a decentralized platform where users can deposit cryptocurrencies as collateral (Ethereum, Chainlink (LINK) and others) and generate/borrow (or borrow) the Dai (DAI) stablecoin, which is paired with the dollar. As a result, there are much lower than the fees charged by banks. In addition to the DAI, MakerDAO also has the MKR governance token.
Curve Finance (CRV)
It is a decentralized exchange for trading stable coins. There is no intermediary to organize purchases and sales in order books as it is a DEX. Instead, prices are managed by algorithms and smart contracts on the platform. Its native token is the CRV.
Convex Finance (CVX)
It is a DeFi protocol that gives liquidity providers from Curve Finance, the project mentioned above, the possibility of earning additional income. CVX is its native token and can use for fee redemption, staking (locking cryptocurrencies to receive rewards), and governance.
InstaDApp (INST)
It is a platform that aggregates several DeFi protocols. Through it, users can check their positions in the various projects and carry out some operations, such as loans and interest gains. It is even possible to migrate debts from one decentralized application to another.
AAVE (AAVE)
It is also a decentralized lending platform where users can lend (or borrow) cryptocurrencies and earn on the interest charged. So, there are no intermediaries in the process, and smart contracts govern everything. AAVE is its native token.
Uniswap (UNI)
It is one of the main decentralized exchanges withinside the cryptocurrency market. Like Cuve Finance and different DEXs, Uniswap has no middlemen powered via way of means of its UNI token. Instead, prices, liquidity, and trading are managed by smart contracts according to previously established rules.
Compound (COMP)
The compound is also a decentralized lending protocol, and its asset is COMP. The project allows users to take cryptocurrencies from others or give them away, earning interest on top of the amounts. Rates are often automatically adjusted according to supply and demand.
How to invest in DeFi
So, there are several ways to invest in DeFi. The main ones are as follows:
Tokens on exchanges
Investment funds
It is also possible to invest through products that apply DeFi resources. In 2021, investment house Vitreo launched funds with partial and full exposure to protocols in this segment. Funds managed by Hashdex, BLP, and QR Asset also have DeFi assets in their baskets. There are options for qualified and retail investors.
Loans and pools
Another way to invest is to keep cryptocurrencies in pools (smart contracts in which users can leave their tokens to generate liquidity) of DeFi platforms or lend the cryptos to other users, earning interest.
How to get a loan on a DeFi platform?
One of the top DeFi lending platforms is MakerDAO. Check out below a step-by-step guide on how to get cryptocurrencies through this protocol.
To borrow DAI, MakerDAO’s stablecoin, you need to leave a cryptocurrency as collateral. The platform accepts assets such as ETH (the most common), LINK, and others. So, it is necessary to have a cryptocurrency wallet compatible with the platform with some units of the crypto asset that will leave as collateral.
One of the wallets that MakerDAO accepts is MetaMask. To use it, just enter the wallet’s website (check if it’s the real one) and add it as a browser extension. Then, you have to go to a traditional exchange where you have an account, buy ETH, and send it to your address on MetaMask.
After sending the ETH units to your wallet, you need to access the “Oasis. app” platform, which allows the user to trade and lend DAI. Within Oasis, which has a others languages version, just click on “Connect a wallet” and click on the MetaMask wallet used in this example. Remember that there are other compatible wallets, such as , Portis, and others compatible with the WalletConnect standard.
After choosing the wallet, the Oasis platform presents a number of cryptocurrencies that can use as collateral. Just click on the desired option and then press the loan button – in the case of ETH, for example, it says “Take a loan with ETH.”
Next, the platform shows the “stability fee” charged to users for the service. Again, this value varies according to the holders’ decision of MKR, which is MakerDAO’s governance token. For example, on January 6, 2022, the rate charged to users seeking a loan was 2.75%.
Advantages of DeFi
DeFi protocols offer some advantages when compared to traditional financial services.
- Costs: Fees charged for DeFi loan applications are often cheaper than those charged by banks or other institutions.
- Borderless: As applications are decentralized and not controlled by governments and banks; anyone can access the services no matter where they are.
- Passive income: When a user lends money to another person or leaves his asset on some platform to generate liquidity, he receives interest.
- Pseudoanonymity: Unlike what happens in banks, to use DeFi services, the user does not need to inform data such as name, address, or CPF. However, access is not 100% anonymous just because transactions; and addresses (sending and receiving IDs) are recorded on blockchains.
DeFi Risks
Like any new technology, DeFi also comes with risks.
- Security: The protocols in this market suffered at least 75 attacks between January 2020 and December 2021, losing US$ 1.7 billion, according to a survey by the Cryptosec website. Cybercriminals managed to break into applications because of flaws/bugs in their code. To guard against this risk, before betting on any project, it is ideal to wait a while to see if it will work.
- Scams: DeFi, like the entire cryptocurrency market, also suffers from scams. In order not to fall into one of them, it is necessary to investigate the project and those responsible before investing any resources. In addition, it is worth looking for information on social networks, forums, newspapers, and even websites that gather legal proceedings in research.
- Difficulty: DeFi is still a complex topic, which can put off users who are not very knowledgeable about the cryptocurrency market. Also, the usability of some platforms is not very user-friendly.
- Volatility: Like cryptocurrencies, tokens from decentralized finance platforms are also extremely volatile. As with BTC, ETH, and others, it is not uncommon to experience daily dips or rallies above double digits.
DeFi: What to expect?
So, the DeFi ecosystem is still in its infancy, but it generates many expectations regarding economic disruptions. Undoubtedly, DeFi protocol platforms have the potential to offer new solutions and applications in the financial field.
This ecosystem is gradually making its way into the future, and the most optimistic hope is that eventually, this resource will become dominant in the coming years.
So, it is always important to note that this is a relatively new service without intermediaries. Therefore, anyone who wants to enter this market should study it carefully.
