In 2018, the DeFi sector revitalized the cryptocurrency industry as it delivered an entirely new ecosystem for conducting finance and commerce. The Decentralized finance trend grew in popularity throughout 2019, and in 2020, it effectively doubled its market share when it grew by nearly 100 million U.S. dollars between April 2020 and March in 2021. Today, it shows no sign of slowing down.
But what are the DeFi benefits that make it so popular? Let’s look deeper into its history and utility to answer this question.
What is DeFi?
Decentralized Finance (DeFi) is a collection of specialized blockchain-based applications and financial services.
The main idea of DeFi is to create an independent and transparent financial ecosystem that is not subject to the influence of regulators and the human factor.
With the help of DeFi, finance becomes available to anyone: users conduct transactions and resolve financial issues directly with each other using decentralized protocols based on smart contracts instead of centralized intermediaries. In this way, users eliminate intermediaries such as banks, courts of brokerage organizations, etc. Software for a decentralized ecosystem allows buyers, sellers, lenders to interact and borrowers.
The difference between centralized (CeFi) and decentralized financial systems is how their users achieve their goals. At CeFi, users rely on the people behind the business and regulatory frameworks. In the case of DeFi, users rely entirely on technology, software code, and encryption algorithms.
Famous Examples of DeFi
Perhaps the most famous example of DeFi is MakerDAO, a decentralized lending protocol. The project’s functionality is extensive, but the main advantage is that it includes a special type of smart contract called “Collateralized Debt Positions”.
With the help of these smart contracts, each user can send a certain amount of ETH to a smart contract and issue their token, backed by a cryptocurrency. At the same time, the generated DAI tokens are, in fact, collateralized debt to MakerDAO. The platform acts as a bank, but absolutely any user can take out a loan. Clients of DeFi services often use borrowed funds to fill liquidity gaps as an alternative to interest rates from a bank loan.
The Unicsoft team collaborated with MakerDao to create an ETL pipeline with a built-in web interface to monitor how it works and set up custom reports. Thanks to this collaboration, MakerDao got a fully automated pipeline that requires minimal support from the client’s side.
Other famous examples of DeFi are InstaDApp, BlockFi, and Compound.
DeFi includes decentralized exchange protocols – Uniswap or Bancor. They allow you to instantly swap one cryptocurrency for another. You can also use forecast services such as Augur and digital asset management platforms like Melonport.
Several DeFi benefits make it a better choice than a centralized financial system. Let’s dive into them:
- Excluding intermediaries. The traditional financial system is based on interacting with institutions (in the form of banks and courts). DeFi applications do not require any intermediaries. Their code is what determines the resolution for any potential dispute. And users, in turn, have control over their funds. This makes it possible to reduce the cost of providing and using products in order to create a more fair financial system.
- Less risk of system failure. Since software deployment for this new type of financial services is carried out on top of blockchain networks, a single point of failure in the system is impossible. Data is written on a blockchain and distributed via thousands of nodes, making censorship or the possible disabling of the service infinitely complex.
- Faster application development. Since the framework allows you to create DeFi applications in advance, their development and deployment have become far less complex and more secure.
- High-level accessibility. Financial services is accessible to people who live in low-income areas. Because the traditional financial system is based on profit-making intermediation, they usually do not offer their services in such areas. However, thanks to DeFi, operating costs are significantly reduced, and low-income communities now have access to these necessary financial services.
What Can I Do with DeFi?
There are three primary ways to use DeFi applications:
- Lending and Borrowing. With cryptocurrency, you can organize a loan via a protocol like Aave or Compound in exchange for interest or fees. You can also borrow digital assets using this type of protocol. This is especially useful if you want to execute or conclude a contract. Note that most DeFi protocols use excess collateral. This means that you have to deposit more than what you intend to borrow or loan. If the value of an asset drops too much, the protocol can take your collateral to avoid losses.
- Trading. With centralized exchanges like Coinbase and Binance, you rely on them to hold your assets for every trade made. As we already mentioned, Decentralized Exchanges (DEX) eliminate intermediaries so people can trade directly with each other. Moreover, DEXs like Uniswap and PancakeSwap allow people to add new tokens for trading.
- Derivatives. If you don’t want to be limited to trading specific coins or tokens, you can use derivatives platforms like dYdX and Synthetix. They allow users to transact leveraged transactions in which they stake more than they have or even create “synthetic assets” that mimic traditional stocks and commodities.
How Do I Use DeFi Products?
Anyone can use DeFi products by going to the app’s website and connecting to a DeFi-enabled crypto wallet like MetaMask on Ethereum or Phantom on Solana. Most DeFi applications do not require users to provide any personal information or register on the site. However, since apps are built on blockchain, you must use the coins of that blockchain to pay for transactions. ETH is required to pay for transactions on the Ethereum network, SOL is required on the Solana blockchain, etc.
In a Nutshell
Decentralized finance creates financial services that are opposite to the traditional economic and political ecosystem. DeFi can create a more open and fair financial system and, best case scenario, eliminate censorship and discrimination around the world.
If implemented successfully, DeFi will disrupt the monopolistic power held by large centralized organizations and hand it over to the open-source software community and many other individuals. However, it cannot be predicted how precisely or effectively this financial system will be against the traditional banking apparatus, especially when decentralized finance goes mainstream and is accepted by the wider populace.
Think about the DeFi benefits that work for your needs. And let professionals help you leverage them in the most effective way possible. The Unicsoft team is always ready to support your ideas and provide the necessary expertise in blockchain solutions.