Times are changing, and at a rapid pace. Old-school video cassettes have been replaced by online streaming services, old good paper books are cast aside for smartphones, and traditional money is being dethroned by cryptocurrencies. Virtual currencies are the latest financial craze!
Too many people seize this emerging opportunity to trade, buy, sell, and invest in crypto to eventually find themselves rolling in money. Blockchain technology is developing at a tremendous rate, and new crypto projects spring up in droves. And they all revolve around one thing – DeFi, or decentralized finance.
- Decentralized Finance or DeFi: What Is It?
- Smart Contracts
- How Does DeFi Work?
- DeFi and Ethereum Blockchain
- Types of DeFi Applications
- Financial Institutions vs. DeFi
- Digital Assets: What Can You Do with DeFi Crypto?
Decentralized finance presents a trustless, transparent, and effective alternative to conventional financial services. It is the main competitor to centralized banks and regular financial institutions whose slow operations, limitations, and high transaction fees no longer meet the demands of tech-savvy customers.
Think of DeFi as an open global financial system designed to be used over the Internet. DeFi brings control and visibility over the funds back to the user. This gives you immediate access to global markets and provides you with effective alternatives to your national currency or financial products offered by your local bank.
Decentralized finance products make financial services available for anyone who has an internet connection and are primarily owned and managed by users themselves. So far, tens of billions of dollars worth of cryptocurrencies have passed through DeFi applications, and this figure is ever-increasing, as surely as the trust of people in decentralization.
The up-and-coming technology, blockchain is to revolutionize and liberate today’s financial world. This article outlines the essentials of DeFi, explores decentralized finance applications, and touches on the main use cases of decentralized finance.
Decentralized Finance or DeFi: What Is It?
DeFi is an umbrella term for financial products and services available to anyone who can use Ethereum Blockchain, i.e. anyone who can go online and surf the WWW. DeFi makes financial markets to be always available, while no centralized authorities can cancel payments or restrict your access to anything.
Services that are otherwise slow and prone to human-factor error in a classic bank or financial institution, are now executed automatically, and they are highly secure because they are processed by the code that anyone can check and polish.
The crypto space is experiencing a dramatic surge in popularity, and for a good reason. This fledgling economy allows you to lend, borrow, invest, and stake your digital assets, so you can earn interest on your cryptocurrencies as a passive income. DeFi users can also take loans and pay them off even without having a bank account or going through any personal identification.
Most DeFi applications and financial products are hosted on the Ethereum Blockchain – the world’s largest crypto platform after Bitcoin. Unlike the Bitcoin Blockchain, Ethereum makes it easy to create different types of decentralized applications on top of it, along with offering faster transaction confirmation times.
The secret of Ethereum’s edge over Bitcoin stems from smart contracts – computer programs stored on the blockchain that automatically execute a transaction when predetermined conditions are fulfilled. Ethereum even created its specific computer languages (such as Solidity) to build and maintain clever contracts.
How Does Decentralized Finance Work?
The work of DeFi projects relies on cryptocurrencies and smart contracts to deliver financial services or products that don’t need any external mediation (such as a local bank). In the modern financial realm, financial institutions act as transactions managers. While helping users send payments all over the world, they also receive tremendous power over users’ personal money. Plus millions of people on the plant still don’t have access to banking services and cannot have a bank account.
In decentralized finance, a role of a transaction manager (and guarantor) will be performed by a smart contract. A contract serves as an Ethereum account that holds a user’s funds, as well as initiates transactions and refunds them upon certain conditions. No one can change this contract while it is running – it will always work as programmed.
For example, if the smart account is designed to pay out an employee’s salary, it can be programmed to transfer funds from Account A to Account B every last Friday of each month. The smart contract will always perform this operation for as long as Account A has sufficient funds. It is impossible to modify it while it is live and steal money from it by adding Account C as a transfer destination.
Smart contracts are also publicly available to be reviewed and audited. This means that even if its performance is compromised, the community will quickly spot and eliminate bugs and vulnerabilities.
However, this never means that you should only trust the most technically-knowledgeable participants of the Ethereum community who can read and refine the smart contract code. The open-source community helps keep developers aware of the inefficiencies, but this need will diminish over time as intelligent contracts are becoming easier to read, and more advanced ways to prove the reliability of code are being developed too.
Decentralized Finance & Ethereum Blockchain
There are some weighty reasons why Ethereum presents the perfect foundation for the development of DeFi applications and platforms:
- Nobody owns Ethereum or the smart contracts that are hosted on it – this allows everyone to take advantage of DeFi. It also means that no one can change the rules described in a contract to the detriment of you.
- All DeFi protocols, services, and applications have a single underplaying level: Ethereum. This means that overwhelmingly all Ethereum-based decentralized finance products will flawlessly work with each other. You can stake tokens on one platform and exchange the gained interest on another market in a completely different application. Ethereum brings all DeFi projects under its roof, giving the much-desired flexibility to how and where you can use your crypto assets.
- Tokens and virtual currencies are embedded in Ethereum, while blockchain allows for tracking the transactions and history of crypto ownership.
- Ethereum provides absolute financial freedom – most DeFi products will never take custody of your electronic funds, giving you full control of your virtual money.
The entire work of DeFi can be divided into four key layers:
- Distributed ledger aka blockchain: it hosts smart contracts and records the history of transactions and users’ accounts.
- The Asset – it is the native token of a DeFi project that can also perform certain functions. For instance, native tokens are required to pay for the services of the project, get rewarded for your contributions to the project’s development, or give you the right to vote on the protocol’s modifications, etc.
- The protocol. A protocol is a set of smart contracts that ensure the operation and security of a given DeFi project. For example, if it is a cryptocurrency lending platform, the protocol will be responsible for executing and verifying the processes of decentralized lending of digital assets.
- Decentralized finance app – they are the products necessary to manage and access the protocol.
Types of DeFi Applications
- Composability: DeFi apps are open-source software, which means the code behind them is available to everyone. Thus, these applications can be used to “compose” new applications using the initial code as a building block.
- Decentralized exchanges (DEXs). A DEX is an online DeFi platform allowing users to sell, buy, and trade their virtual currencies, whether it is fiat-to-crypto, crypto-to-crypto, or crypto-to-fiat. A DEX has a peer-to-peer nature. It means the platform directly matches buyers and sellers, so that they can transact with each other, without asking banks to help carry out a transaction. This is what sets a DEX apart from a centralized exchange that requires a middle man to handle a transaction.
- Lending platforms. Such platforms employ smart contracts to offer crypto lending services without involving brokerage such as centralized banks.
- Liquidity mining: it is a situation when a DeFi application is trying to attract more users to their platform by giving them free additional tokens. It is the most hyped form of yield farming.
- Money legos: taking the concept “composability” to the next level, DeFi applications are like Lego pieces – small bricks and blocks used to construct buildings, machines, etc. DeFi apps can be put together like money Legos to create new financial products.
- Prediction markets. A modern twist on traditional betting, prediction DeFi platforms allow you to bet on the outcome of future events and make money if your prediction proves correct. Such services are provided without centralized intermediaries as well.
- Stablecoins. It is a type of digital asset whose price is tied to the price of some real-world asset such as the US dollar, Euro, or gold to keep its market value always at the same level.
- Wrapped Bitcoin (WBTC): It is an ERC-20 token that represents Bitcoin (BTC) in the Ethereum DeFi systems. WBTC allows users to earn interest on their Bitcoin by lending their assets via the decentralized DeFi lending platforms.
- Yield farming: it is the way to make more cryptocurrency with your cryptocurrency. This assumes that you are lending your crypto funds to other people through smart contracts. In exchange for your services, you receive a reward in the form of cryptocurrency. Though yield farming sounds simple, the most lucrative strategies are incredibly complex, involve solid risk, and are only recommended for experienced traders who know how to protect their investments.
Financial Institutions vs. DeFi
It is best to see the potential of DeFi in the light of the problems that plague traditional financial organizations:
- Too many people cannot access a bank account or take advantage of effective financial services.
- The inability to access adequate banking products and services deprives people of an opportunity of getting employed.
- Poor financial services can hinder you from receiving payment.
- Central financial systems have access to your personal information and can secretly use it for their own benefits.
- Governments and centralized banks can close markets at any time.
- Trading hours are often limited to business hours in a specific time zone.
- Transactions can take several workdays due to slow processes and human errors.
- Financial services establish elevated fees because intermediary institutions want to capitalize on your needs.
DeFi vs Central Bank Comparison
|You hold your funds.||You trust your funds to other companies.|
|Your money and how it is spent is entirely controlled by you||You never know whether companies effectively manage your money and don’t give it to risky borrowers.|
|Money transfers are executed nearly instantly||Transfers can take several business days to complete.|
|Transaction operations are anonymous or semi-anonymous.||Financial activity is tied to your identity.|
|The markets are always open.||Markets have inconvenient working hours and are always closed on weekends and holidays.|
|DeFi takes the principle of transparency – anyone can view transaction data and inspect how the system works.||Financial establishments are not publicly available: you cannot ask to have a look at their loan history, records of their managed assets, etc.|
Digital Assets: What Can You Do with DeFi Crypto?
Decentralized finance represents a powerful alternative to most traditional financial services typical for banks and financial institutions. Here are just a few of the many ways how you can utilize digital money.
Send money around internationally within seconds
Ethereum is designed to send transactions securely and globally. Like Bitcoin, Ethereum makes transferring money around the globe as easy as sending emails.
Choise.com, for example, allows sending different tokens to other users anywhere in the world using only their phone number, even if they have never owned crypto before and have no digital wallet.
Just enter the recipient’s number from your phonebook, and your payment will go straight to them in a few instances (usually). They will receive a link with a newly-generated hot wallet where the transferred tokens are happily sitting ready to work.
Stream money globally
You can also stream money via Ethereum. This allows you to pay someone their salary per second, giving them access to their money when they need it. And if you don’t want to send or stream crypto because of their inherent volatility, you can benefit from ever-stable alternative currencies on Ethereum called stablecoins.
Coins such as Dai or USDC never suffer from price fluctuations because their value is pegged to a real-world asset like the US dollar. This makes them ideal for paying or spending. Many people in Latin America have used stablecoins as a way to protect their savings during times of great uncertainty with their national currency.
There is no shortage of borrowing providers in the DeFi space. Borrowing is generally done in two ways:
- Peer-to-peer borrowing. It is when a user who needs money (borrower) takes a loan directly from a user who provides money (a lender).
- Pool borrowing. It is when lenders deposit tokens to liquidity pools that borrowers can take money from.
The greatest advantage of decentralized lending and borrowing is that the transacting parties don’t need to identify each other. Instead, the borrower must provide collateral, which the lender will automatically receive if the loan is not returned. This allows you to borrow money without credit checks or sharing personal information.
With borrowing, you can access a loan without the need to sell your ETH (a tax-exposed event). Rather, you can use your ETH assets as collateral to get a credit. This gives you the cash you need while you also preserve your ETH.
Another perk of decentralized borrowing is that it offers flash loans. A flash loan is nascent a form of crypto lending wherein you can borrow without providing collateral and without revealing your personal information. The principle of unsecured flash loans includes taking the loan from the liquidity pool and paying it back within the same transaction. If the loan cannot be returned, the whole transaction reverses and undoes all previous actions as if nothing has happened.
Earning passive income with DeFi tokens
You can earn interest on your ETH-based tokens by lending your assets to liquidity pools and reaping juicy gains on your electronic capital. Today, many decentralized finance platforms offer significantly higher interest rates compared to conventional banks.
For instance, Choise.com allows its customers to set up a savings account and earn up to 15.6% annually on their virtual holdings – such generosity is impossible to be found with regular banks.
The giant Ethereum Network is home to thousands of tokens. Decentralized exchanges provide an opportunity to trade different tokens with extreme ease. Unlike traditional finance markets (Forex for example), such exchanges are available 24/7, 365 days a year, and the blockchain technology guarantees there will always be someone to conclude a trade with you.
Grow your investment portfolio
There are fund management projects built on top of Ethereum that will help you to expand your portfolio based on your chosen investment strategy. This happens automatically, is available to everyone and does not require the involvement of a manager to grab a share of your profits.
Fundraise your project
Ethereum is also known for enabling the creation of crowdfunding applications for fundraisers. Smart contracts in such apps will determine the logic of how funds must be locked and when they can be withdrawn (for example, when the fundraiser has fulfilled certain obligations). Thanks to the transparency of blockchain, sponsors can easily track the process of fundraising and see how funds are spent in the future.
Decentralized insurance is designed to make insurance cheaper, faster, and more efficient. With the more automation ensured by smart contracts, coverage becomes more affordable and payouts are processed much faster. The circumstances to decide on the claim are also completely transparent.
Choise.com is an all-in-one crypto wallet allowing you to unleash the potential of DeFi cryptos. Choise.com offers major DeFi services in one nifty solution, including an exchange, crypto loans, savings accounts, managed portfolio, price predictions, as well as fiat-to-crypto purchases, portfolio management, and instant crypto transfers. With Choise.com, the best what DeFi has to offer is at your fingertips.