One area of cryptocurrencies that is currently attracting a lot of attention is DeFi (Decentralized Finance) or decentralized finance. It is an ecosystem of financial applications (built on blockchain networks) that use smart contracts or Smart Contracts, which are automated execution agreements that do not require intermediaries, such as a bank or a lawyer, and instead, use blockchain technology.
The world of cryptocurrencies is expanding at a relentless rate. What started with a simple technology that supports Bitcoin (blockchain) has grown into an entire industry unto itself.
If you are an enthusiastic follower of the Bitnovo blog, you will already know that one of the most interesting features of Bitcoin and most other cryptocurrencies is that they are decentralized, which means that they are not subject to the control of any government or financial institution.
However, as the cryptocurrency space expands its horizons, the original idea of decentralization discussed in the 2008 Bitcoin white paper continues to weaken.
To make the different cryptocurrencies interoperable and obtain synchronization between them, solutions have been implemented in the form of poorly planned gateways. All of this has made the crypto space a loosely connected infrastructure, the repercussions of which will be amplified as the use of cryptocurrencies in everyday applications increases. The trading exchanges in the cryptocurrency space are centralized because of this reason.
This has been the norm until now. Imagine that, ironically, cryptocurrencies, which spoke of economic decentralization, are exchanged and stored in centralized wallets/wallets. Fortunately, this paradigm is changing as many in the cryptocurrency universe are convinced that the era of centralized cryptocurrency exchange must end.
What is Defi: definition
And so DeFi – DECENTRALIZED FINANCE – was born, whose purpose is to create an open-source and transparent financial services ecosystem that is available to everyone and operates without any central authority. Users would retain full control over their resources and would interact with this ecosystem through peer-to-peer (P2P) and decentralized applications (Ðapps).
Therefore, if cryptocurrencies promise to make money and payments universally accessible to anyone, regardless of where they are in the world, the Decentralized Finance (Defi) or Open Finance movement takes this promise one step further.
Decentralized finance is nothing but a collaboration of traditional banking services with decentralized technologies. Decentralized technologies are cryptocurrencies and decentralized applications (Ðapps). Technically, it refers to the union of all decentralized products and services such as smart contracts, protocols, and applications.
Decentralized finance development creates a financial system open to all and minimizes the need to trust central authorities, thanks to technologies such as the Internet, cryptography, and blockchain.
DeFi, thanks to blockchain technology, allows anyone to verify any transaction that occurs on the blockchain and therefore to take charge of their financial well-being-without having to rely on a central authority.
What are the benefits of Defi?
But for you to understand the scope of DEFI, we are going to show you the main characteristics of decentralized finance.
- Unauthorized: DeFi system blockchains do not need authorization, allowing anyone to access applications on a DeFi protocol and trade on the network.
- Accessibility – Anyone from any corner of the world can join the DeFi world. All that is needed is a device like a PC or a smartphone and a decent internet connection. This characteristic, in particular, certainly gives decentralized financial systems the advantage over traditional banking systems, since it takes into account that portion of the world’s population that cannot access or use essential banking services.
- Interoperability: Defi is easily compatible with the integration of other applications, so you can expand further, offer new services and even develop new financial markets.
- Transparent and Open Source (open source): The code is Open Source on a Defi system. Without interfering with the privacy of users, the code is visible to each user. The code can be verified for security and controlled by each user. These are identified by their digital signatures.
Decentralization of financial services
The second phase of DeFi began in 2020. With the cooling of the ICO market, other projects started to appear in the market. And their goal was to revolutionize not just a specific industry, but the entire economy. Now, DeFi was ready to operate in the following markets:
- Issuance of debt with collateral;
- Receive interest on invested cryptocurrencies;
- Buying and selling option protection;
- Futures Markets;
- Make and trade synthetic assets (such as gold and stocks) on the blockchain;
- And others.
It is possible to notice that all these services exist in the traditional market. DeFi, therefore, did not necessarily create new financial products. What they did was bring those markets to blockchain technology. And this transaction came with several improvements, especially in the ease of access.
Consider opening a bank account. This process is often very complicated and, in some cases, expensive. Not just anyone can open a bank account and have access to investments. In poor countries, which suffer from high inflation, such a limitation can mean the difference between living and dying.
DeFi cuts these intermediaries. Banks, brokerages, finance companies, and stock exchanges are not needed. Anyone with Internet access can connect to a computer and have access to DeFi services. The costs are much lower, the speed is higher, and there do not exist restrictions geographical or financial.
As a result, several projects started to receive capital from investors who believe in the potential of DeFi. Some of these projects received in the billions. This metric is measured by Total Allocated Value (TVL), which shows which projects receive the most investment. The DeFi Pulse website has a complete list, in order of allocated value.
What are the possible use cases for DEFI?
The main use cases of Defi are as follows:
Loans and Crypto loans
P2P (peer-to-peer) lending and lending platforms are some of the most used applications of the DeFi system. These are usually simple decentralized applications (Ðapps) that make it possible to grant loans to individual borrowers or organizations reliably, without third-party interference and allow lenders to earn cryptocurrencies as their interest
Therefore, open and decentralized loans have many advantages over the traditional credit system, including:
- Easy access for both lenders and borrowers
- Instant fund settlements through smart contracts
- The ability to secure digital assets
- Total transparency in the flow of funds
- No credit check
- Reduced risks
- Loan flexibility
The DEX Compound platform is a good example of the DeFi protocol.
Staking is the process to help participate in the network governance of Proof-of-Stake (POS) blockchains, delegating digital resources to a validation node or simply keeping these digital resources in a compatible wallet.
When users help protect the blockchain through the accumulation of resources, they win rewards that are delivered by the network. Some of the popular stackable assets are Tezos (XTZ), Tron (TRX), and Cardano (ADA).
Decentralized DEX / Exchanges
One of the best-known use cases for DeFi is DEX. Decentralized exchanges are cryptocurrency exchange platforms that allow all users to carry out P2P (peer-to-peer) transactions with each other and control their funds independently and without intermediaries. The DEX provides greater liquidity, protects all personal data of users and their funds, and reduces the risks of manipulation of the market by a considerable margin.
Currently, there is a range of Defi platforms that offer insurance against any unforeseen ( a market crash, a hack, the failure of a smart contract ). Nexus Mutual is one example.
Unlike traditional insurers, decentralized insurance allows a group of investors to share the risk among themselves in exchange for the insurance premium.
These are platforms built using publicly visible smart contracts, which means that payment terms guarantee maximum transparency.
Money banking services and Stablecoin
Since Defi applications are financial, money banking services are an obvious use case. These can include stablecoin issuance, loans, and insurance.
As the block industry matures, more attention is being paid to stablecoin creation.
Stablecoins are a type of digital asset whose value is linked to another asset (for example, fiat currencies such as the US dollar (USD) or the euro (EUR)) to keep the price as stable as possible and to reduce volatility.
Regarding mortgages, due to the number of intermediaries that must be involved, the process of obtaining a mortgage is expensive and time-consuming. Legal fees can be significantly reduced by using smart contracts,
Lastly, when it comes to insurance, when it is managed using blockchain technology, the need for intermediaries could be eliminated and the risk spread among many participants. This could mean lower premiums with the same quality of service.
The peer-to-peer payment system is one of the basic characteristics of decentralized finance. DeFi payment networks create a convenient financial system for the large part of the world’s population that is still devoid of banks and allow all users to negotiate directly with each other, without the need for third parties.
The token is another specific case of DeFi. Virtual assets issued and managed on a blockchain are called a token. Tokenization is a native feature of the Ethereum blockchain, which means that it can provide DeFi platforms on the same blockchain with several economic benefits.