What is DeFi? Understanding the Concept and uses of Decentralized Finance

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DeFi (Decentralized Finance) is currently one of the hottest topics in the world of cryptocurrencies, and it is expected to change the way we use banking services in the future. In practice, DeFi means that traditional financial services are incorporated into a decentralized blockchain, eliminating the need for third parties, such as banks.

Over the past few months, the cryptocurrency market has welcomed incredible developments thanks to DeFi or decentralized finance intervention. This financial system includes digital assets, protocols, smart contracts, and dApps, made with the famous blockchain technology (chain of blocks).

Decentralized Finance (DeFi) is a highly topical entity closely related to the Ethereum platform. DeFi is a generic term for various services that seek to build a completely new financial sector that is not dependent on the traditional banking world. In theory, DeFi is not tied to any single blockchain-based platform, but in reality, most DeFi services run on top of the Ethereum platform. Trading on the Ethereum platform means that currently, most popular DeFi services on the market do not have their own blockchain. Hence, all their operations occur on the Ethereum blockchain.

Cryptocurrency volatility was always the number one reason to minimize its adoption rate and prevent investors from regarding crypto as a true alternative to displace traditional financial assets. However, with DeFi on the market, it’s moving on to become what seems like the ultimate investment choice for digital assets in the global economy.

Before explaining what DeFi is all about, let’s analyze the current financial landscape.

Traditional financial system

The traditional financial system is governed by the governments and banks, where everyone deposits their money for a negligible amount of interest for the money left untouched for a period of time. However, while your money is in the bank, it’s being used to invest in large international funds that generate enormous profit for the banking institutions.

Have you ever wondered why you can’t just get all your money out of the bank? Precisely because the bank uses it to multiply its reserves and interest on loans and credits makes the banking business one of the strongest globally. This might be something cool for traditional financial companies, but not so much for users who not only have no control over their fiat but are under the risk that the value of their savings will decline if the country suffers from inflation. Even in a stable economy, the interest earned in a regular savings account is not the most impressive.

Cryptocurrencies were created to empower people, digital assets that are not governed by a specific national economy and do not need an intermediary. However, these are not totally detached from the traditional financial system since most need intermediaries (centralized platforms and projects) to make changes or store them in your digital portfolio. This is where DeFi comes in to change the landscape.

DeFi’s contribution to freer trade

Imagine a system where the user has total control of their operations. They do not have to save their money in a bank or pay or collect through intermediaries, a secure platform, and immutable smart contracts. Yes, this is DeFi, and its ecosystem seeks to give flexibility and guarantee to those who use it.

How is this accomplished?

With open-source smart contracts are fulfilled automatically when there is an agreement between two or more parties.

Within DeFi, you have tools and services that you can combine and modify according to your needs. Currently, the best platform for decentralized finance is Ethereum, which offers a framework that fits it. This is the main reason why specialists believe that Ether would skyrocket in value in the nearest future because of its integration into almost all parts of the crypto economy.

Ethereum among crypto users and enthusiasts has high reliability, even more than bitcoin, since its platform advocates for total control by the user, without anyone being able to scam or manipulate the system. Its operation has been effective since its creation in 2015, with the version 2.0 release being expected soon.

Bitcoin’s slow growth and diminishing dominance

Bitcoin is the cryptocurrency with the highest value, even higher than gold which is a standard financial asset for global economies; however, over the past months, it has stagnated in adoption; even though it’s still popular, it’s no longer dominant as it used to be in the past.

However, this decline will not last long because although the ideal platform for DeFi is Ethereum, the main cryptocurrency will be one of the most important tokens to trade.

Main DeFi Services and Applications

Loans

Generally speaking, loans occupy most of the DeFi market, more than 80% of TVL(Total Value Locked). In addition, Aave is the dominant leader, already encompassing almost 25% of the locked value within this sector. Cryptocurrency interest rates range between 0.8 and 6% (APR) for BTC, between 1.1 and 2.61% (APR) for Dai, and between 0.54 and 8.6% (APR) for USDC.

Other rising stars in lending include Liquity and DeFi Saver.

Derivatives

While traditional derivatives cover hundreds of trillions of dollars within the market, derivatives based on DeFi reach, at the moment, are just over $130 million, but their growth potential is enormous. Derivatives from projects such as Synthetix and Nexus Mutual currently total more than $150 million in TVL.

In fact, Synthetix has largely driven the growth of this DeFi sector and currently leads 94% of derivatives trading.

DEXs

Decentralized exchange (DEX) has been crucial to the success of Ethereum and to build an inclusive global financial system. While it is true that in recent years we have seen multiple DEX attempts that allowed anyone to buy and sell crypto assets, most of these projects have largely failed due to a lack of traction in aspects such as decentralization, security, or utility.

The most prominent DEX in the DeFi space is Uniswap, with a 70% market dominance. Other prominent DEXs are Bancor, Loopring, and Kyber.

Assets

Assets are the least represented DeFi space, with just over $40 million in TVL. It is basically made up of the Set Protocol and the Wrapped Bitcoin (WBTC).

The Set Protocol allows free access to smart assets within a diversified portfolio on a single ERC20 token. The token can automatically rebalance itself to a certain set of parameters established at the time of its creation. In other words, the Set Protocol allows users to have an autonomous portfolio that does not require management by the investor.

For its part, WBTC has created a mechanism for Bitcoin to work on the Ethereum blockchain as an ERC20 token, so it can become a way to attract liquidity from the Bitcoin ecosystem. It should be noted that WBTC’s dispute with the Lightning Network as an alternative for Bitcoin transactions has pushed its value higher.

Stablecoins

DeFi’s takeoff wouldn’t be possible without stablecoins. Dai has played a key role within DeFi. MakerDao’s underlying protocol has served to strengthen its stablecoin, But all other loan protocols have also found in Dai a basis for their markets.

For their part, other cryptocurrencies based on the price of the US dollar or other “stable” values such as AnchorUSD (USDX), EOSDT or USD Coin (USDC), among others, are the catalyst for Decentralized Finance and even offer interest for having deposits in those virtual currencies.

With the recent departure of TrustToken from Compound, the role of its consensus protocols is evident. Compound’s COMP protocol has introduced a community governance system that allows users to suggest and vote on protocol changes. A vote-based consensus mechanism is similar to that used by Maker (MKR) or EOS (EOS).

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