#DeFi decentralized Finance
Tomas Medeckis
Head of the Polish, Latvian and Estonian markets for DIONE and KAR KAR ice cream brands
What is decentralized finance (DeFi)?
Cryptocurrencies have exploded into a?trillion-dollar?industry today, sparking a wave of worldwide financial disruption.
At the heart of cryptocurrencies is a remarkable history of innovation that goes back to the 1980s, with advancements in cryptography. Since then, a series of events have shaped crypto space; the first cryptocurrency, Bitcoin, being the most prominent. Despite its spectacular growth in the past 12 years, financial services have very slowly appeared for Bitcoin — mostly due to its inherent lack of stability and adoption. Mainstream institutions won’t accept a Bitcoin loan because of its significant price volatility — it makes Bitcoin a poor asset to plan any investment accurately.
Things change quickly in the crypto space, and decentralized finance (DeFi) is a current trend — it's an exciting space to be, undoubtedly. If you're still unaware, let’s dig a little deeper into DeFi and learn more about it.
Decentralized finance (DeFi) explained
Short for decentralized finance, DeFi is an umbrella term for a variety of applications and projects in the public blockchain space geared toward disrupting the traditional finance world. Inspired by blockchain technology, DeFi is referred to as financial applications built on blockchain technologies, typically using smart contracts. Smart contracts are automated enforceable agreements that do not need intermediaries to execute and can be accessed by anyone with an internet connection.
DeFi consists of applications and peer-to-peer protocols developed on decentralized blockchain networks that require no access rights for easy lending, borrowing, or trading of financial tools. Most DeFi applications today are built using the Ethereum network, but many alternative public networks are emerging that deliver superior speed, scalability, security, and lower costs.
Why smart contracts?
Most smart contracts offer Turing Complete programming languages that allow multiple parties to interact with each other, without needing a centralized intermediary. Blockchain’s ability to capitalize on smart contracts has made them ideal platforms to choose when building out financial applications.
How did DeFi get its start?
Humans bartered initially for goods and services. But, as humans evolved, economies evolved: We invented currency to make it easier to exchange goods and services. Subsequently, coins helped usher in innovations and created better levels of economies. However, progress comes at a cost.
Historically, central authorities have issued currencies that underpin our economies, which eventually gave them more power as more people began to trust them. However, trust has been broken from time to time, which makes people question the centralized authorities' ability to manage said money. DeFi was developed based on the idea of creating a financial system that is open to everyone and minimizes the need to trust and rely on a central authority.
It’s argued that DeFi started in 2009 with the launch of Bitcoin, which was the first p2p digital money built on top of the blockchain network. Through Bitcoin, the idea of ushering transformation in to the traditional financial world using blockchains became an essential next step in the decentralization of legacy financial systems. The launch of Ethereum and, more specifically, smart contracts, in 2015 made it all possible. The Ethereum network is a 2nd generation blockchain that first maximized the potential of this technology within the financial industry. It encouraged businesses and enterprises to build and deploy projects that formed the ecosystem of DeFi.
DeFi brought a plethora of opportunities to bring about a transparent and robust financial system that no single entity controls. But the turning point for financial applications started in 2017, with projects facilitating more functionalities in addition to just money transfer.
Challenges within centralized finance
Financial markets can enable great ideas and drive the prosperity of society. Still, power in these markets is centralized. When people invest in the current financial system, they relinquish their assets to intermediaries, such as banks and financial institutions — this keeps the risk and control at the center of these systems.
Historically, we’ve seen bankers and institutions failing to see risks in the market, as seen in the?2008 financial crisis. Undoubtedly, when central authorities control money, risk accumulates at the center and endangers the system as a whole.
Bitcoin and early cryptocurrencies, which were initially developed to give individuals complete control over their assets, were only decentralized when it came to issuance and storage. Providing access to a broader set of financial instruments remained challenging, up until the emergence of smart contracts and that enabled DeFi.
DeFi protocols and how they work
DeFi has grown into a complete ecosystem of working applications and protocols that deliver value to millions of users. Assets worth over?$30 billion?are currently locked in DeFi ecosystems, making it one of the fastest-growing segment within the public blockchain space.
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Here's an overview of the most popular DeFi use cases and protocols available in the market today:
DeFi lending and borrowing
DeFi gave finance a new direction by enabling lending and borrowing. Widely regarded as ‘Open Finance’, decentralized lending offered crypto holders lending opportunities to gain annual yields. Decentralized borrowing allowed individuals to borrow money at a specific interest rate. The aim of lending and borrowing is to serve financial service use cases while fulfilling the needs of the cryptocurrency community.
Top DeFi lending and borrowing platform: Compound Finance
Launched in 2018,?Compound Finance?is the brainchild of Rober Leshner. The project is a lending protocol developed on the Ethereum blockchain that allows users to gain interest by lending out assets or to borrow against collateral. The Compound protocol makes this possible by creating liquidity for cryptocurrencies through interest rates set using computer algorithms.
How does Compound work?
Users of Compound earn interest by depositing cryptocurrencies. Here's a?list?of cryptocurrencies that can be deposited on the protocol, along with the expected Annual Percentage Yield (APY). Once cryptocurrencies are supplied on the Compound platform, users can use them as collateral for loans.
Compound token: $COMP
$COMP, the governance token for Compound protocol, is a token used by its holders to suggest and implement development changes to Compound protocol. Changes include:
Decentralized exchanges
Decentralized Exchanges (DEx) are one of the essential functions of DeFi, with the maximum amount of capital locked compared to other DeFi protocols. DExs allow users to exchange or swap tokens with other assets, without a centralized intermediary or custodian. Traditional exchanges (centralized exchanges) offer similar options, but the investments offered are subject to that exchange's will and costs. The extra cost on each transaction is another negative aspect of CExs, which DExs address.
Top decentralized exchange: Uniswap
Founded in 2018 by Hayden Adams,?UniSwap?is the largest automated token exchange by trading volume deployed on the Ethereum blockchain. The project was launched after receiving grants from multiple capital ventures, including the?Ethereum Foundation. UniSwap automated transactions between cryptocurrencies through smart contracts.
How does it work?
UniSwap today offers three functionalities: Swapping tokens, adding liquidity, and removing liquidity.
Swapping tokens
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