DeFi, or Decentralized Finance Assets, is an opportunity that allows financial transactions such as lending, borrowing and trading to be released without centralized systems. You can perform these operations through decentralized applications that are deployed on the Ethereum platform, in particular Dapps — are digital applications or programs that generate tokens. Also, DeFi is not a «single» product, it’s a system in the form of a «constructor» that includes a set of products and services which replace such financial structures as banks, insurance companies, bond and money markets.
Obviously, this system is not simple and has varying degrees of decentralization.
The protocols are custodian, use centralized price feeds, set interest rates, centrally provide liquidity for margin calls (forced closing of a deal by a broker when a certain drawdown is reached on it.)
Non-custodial, decentralized price feeds, free access to initiate margin calls and margin liquidity, decentralized development.
All components are decentralized.
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The DeFi ecosystem has a lot of potential staff and covers many financial categories and aspects beyond technical. Also, this system is not stable, as it develops very rapidly. Many projects are developing so quickly that DeFi may soon be completely different from the present one.
These are the main categories that DeFi currently includes:
Cryptocurrency prices are very volatile, as is the market itself. According to statistics, daily rate fluctuations often exceed 10%. To normalize this volatility, stablecoins were created — coins tied to stable assets. Tether (USDT) was one of the first centralized stablecoins. Each USDT is backed by $ 1 in the bank account of its issuer. However, one of the main disadvantages of USDT is that users must trust its issuer and that USDT is fully collateralized and corresponding dollar reserves do exist.
Users have bank accounts to use their services — an opportunity that is not currently available to everyone. Getting a loan from a bank comes with constant constraints such as having a good credit rating and sufficient collateral. Decentralized lending and borrowing removes this obstacle and allows everyone to use their digital assets as collateral to obtain loans. It is also possible to make money on this by contributing the assets to credit pools. With such a system, there is no need for a bank account or credit check.
Decentralized exchanges allow users to exchange cryptocurrencies without having to transfer their coins to a custodian.
A document certifying the right and obligation to purchase or sell in the future securities, a contract, the value of which is derived from another underlying asset. Traders can use derivatives to hedge their positions and reduce risk in any trade. Thus, to protect yourself from the growth of market changes in the future, you enter into a futures contract with stable conditions, agreed today. Derivatives are mostly traded on centralized platforms.
The process of overseeing your assets and managing the cash flow to receive. While active portfolio management needs a team of portfolio managers making investment decisions to generate income, passive portfolio management does not require such a team, it involves imitating the return of a certain benchmark as much as possible. DeFi’s transparency allows for the development of passive management. In this case, it is easy for users to track how their assets are being managed.
New creative and disruptive financial applications are coming out all the time, but with the development of decentralized finance, this process will double accelerate. Extending DeFi principles to lotteries allows transferring control of the prize pool to a smart contract on the Ethereum blockchain. Thanks to the modularity of DeFi, you can link a simple centralized lottery app to another DeFi app and create something more advanced.
The role of cryptocurrency is that it is possible to exchange this asset without intermediaries. With the development of DeFi, there are even more experiments with innovative ways.
The risk in which a person receives financial protection or damages from an insurance company in the event of an accident. This trend is common in many countries of the world, in all areas — from real estate to medicine. But is there decentralized insurance for DeFi? Although the code of most projects has been audited, we can never be sure that they are completely secure. There is always the possibility of hacking, which can lead to losses. Therefore, it forces people to look for insurance opportunities in a decentralized system.
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The total value of the assets involved in the DeFi system had already reached $ 667 million at the beginning of 2019, and more than $1billion in 2020. This is the amount of total programmable money that is currently stored in smart contracts that serve as building blocks. The rapid development suggests more promising and rapid use of this technology in the near future. This system promotes the world where financial management will become an innovation and the user will receive a huge number of opportunities not only to manage finances, but earn on them every year as well. And who knows, maybe the need for centralized financial systems will soon disappear, and DeFi will be able to completely replace them.