Decentralized finance: “Flexible finance” (DeFi) refers to the financial services made possible by blockchain technology that do not include any middlemen from central banks. Bitcoin, the first digital currency to enable users to transfer funds amongst each other autonomously from a central bank, was not known as “DeFi” when it became available in 2009. Bitcoin was one of the first cryptocurrencies to use digital currency for trade and investment. The innovative concept of Bitcoin did not belong to Wall Street financiers and central banks because of the network’s trustlessness.
The smart contract feature was introduced during the establishment of Ethereum. In addition to facilitating the transfer of digital assets, developers can model additional aspects of the conventional financial system decentrally through immutable code.
Cryptocurrencies could be used for various financial activities after this, including lending and borrowing, trading, insurance, venture capital, and derivatives market participation. Not only that but after launching, other smart contract platforms such as Solana and Avalanche also witnessed a boom in their DeFi ecosystems.
By the numbers
Many DeFis, or decentralization financial applications, were launched in the summer of 2020 and gained widespread adoption shortly after. These apps included Compound, a platform for lending and borrowing, Yearn Finance, an exchange, and many more. Thanks to this first boom, by September of that year, the total value locked (TVL) in DeFi protocols across all blockchains had nearly risen to $10 billion. Following a brief lull, a growing amount of capital poured into DeFi protocols, pushing the TVL to over $180 billion by 2021.
What is the role of DeFi?
An integral feature of Web3, DeFi’s alternative banking system gives individuals complete command over their assets and interactions with third parties. The fact that it does away with so many problems associated with conventional banking has contributed to its meteoric surge in popularity. Consider the procedure for obtaining a loan from a conventional bank, for example. Getting a loan requires an application and approval process. The bank charges a fee to handle the loan on your behalf and sets the rate. You have no say in whether or not they choose to move your loan to a different servicer.
This is only one little illustration of how decentralization of finance has helped people. No one is ever denied access to DeFi’s services because of its lack of “gatekeeping,” anyone can utilize its decentralized applications (apps) without going through the application procedure. Rates are typically more equitable because market forces like supply and demand determine them. Trades on the most well-known AMM DEX went over $1 trillion.
Additionally, you can switch platforms if you find a better price with another one. Finally, although banks are only open for business 8 hours a day, DeFi is open 24/7 and offers a transparent, efficient, and fast alternative to do financial transactions.
Limits of DeFi
One thing to remember is that not all platforms make good on their decentralization claims. There are instances where the original team or a select few individuals have disproportionate power on a platform. The governance vote on the Solend platform in June 2022, built on Solana, was a prime example of this, as a single user won it. The original decision was swiftly undone when it provoked a backlash.
The vulnerability to cyberattacks is another drawback. A hacker may potentially drain funds from a DeFi protocol irretrievably if they were to exploit any vulnerability in the platform’s back-end code. Users lost over $600,000 at Curve Finance in August 2022 because this happened on the platform’s front end, such as a website. This type of finance, which relies on blockchain technology, is subject to different regulations than conventional finance. Users should conduct their research before utilizing a platform and be mindful of these when engaging with its extensive services.
What are some examples of DeFi in action?
DeFi has grown to offer other services since its establishment. It’s hard to list all popular decentralized finance examples: Decentralised stablecoins: Protect cryptocurrency investors against exchange instability and fiat conversion. In 2017, MakerDAO proposed a decentralized uncollateralized stablecoin. The new DAI currency supports existing cryptocurrencies and stays at $1. Borrowing and lending: Some platforms let users borrow assets like bank loans for DeFi applications or investments. Smart contracts let yield farmers lend assets for interest and rewards. The Aave network, which relies on Ethereum, now allows users to borrow and lend money on Blanche, Fantom, Optimism, and Polygon.
Asset trading involves stock buying and selling. Asset market liquidity typically originates from “market makers”—large investors or institutions. DEXs pool assets for liquidity using the AMM smart contract. The liquidity providers take a cut of token swappers’ funds. Consider Uniswap. Trades on the most well-known AMM DEX went over $1 trillion. Stablecoin DEX Curve Finance is popular for token trading. Traditional commodity and securities markets trade asset derivatives. Option and futures contracts help investors estimate prices. The DeFi cryptocurrency exchanges permit the trading of derivatives. DYdX sells perpetual futures.
Decentralized insurance has become popular to protect the currency from DeFi’s hacking and smart contract flaws. Users can pay to retrieve DeFi protocol assets. Nexus employs NXM money for decentralized insurance. Policyholders pay DeFi premiums; token holders get a share. Venture funding: ICOs popularized cryptocurrency financing in 2017. Crowdsourcing has become popular for project funding. Para chain crowd loans enable Polkadot blockchain application enrollment. Projects must bid for parachain slots. Users frequently receive the project’s cryptocurrency to lock up their DOT.
Decentralized finance essentials
An umbrella term for various financial services that cut out the intermediaries that traditional banking is now reliant on is “independent finance” (DeFi). There has been a meteoric rise in the use of DeFi since 2020. The DeFi ecosystem’s numerous decentralized applications (apps) have received billions. Dollars in funding, but not before experiencing the growing pains of protocol hacks and smart contract vulnerabilities.
Decentralized financial applications facilitate various useful activities, including creating stablecoins, loans, borrowing, trading assets and derivatives, insurance, and venture capital.
