Examples of Decentralised Finance

Decentralised finance is the new way of doing business that is taking over the financial sector. Some trackers quote that a mAssive $40 billion is locked in DeFi ...and there is much, MUCH more to come...

Today, we're going to explore what is DeFi and how it works.

What is Decentralised Finance?

Decentralised finance, or "DeFi" for short, sidesteps traditional financial intermediaries like banks, stock exchanges, and credit rating agencies. This means that instead of going through a bank or other financial institution, you can use defi protocols to interact with the blockchain and execute financial activities directly.

DeFi platforms are built on Ethereum and other blockchain networks, and they use smart contracts to automate financial transactions.

This has a number of advantages. First, it makes transactions much faster and cheaper, since there are no intermediaries to slow things down or take a cut. Especially when it comes to weekends, bank holidays or cross-border payments, second, it makes them more secure, since a set of algorithms define how assets are moved instead of mistake-prone humans.

But to truly understand defi we need to talk about one of the first defi projects to capture the minds of investors.

The Rise of MakerDAO

In traditional finance, if you want to take out a loan in US dollars, you would go to a bank. The bank would then lend you the money, and charge you interest.

With MakerDAO, things are different. Instead of going to a bank, you can go to the Dai Platform on Ethereum and take out a loan in Dai. (Dai is the MakerDAO stablecoin, which is pegged to the US dollar).

The loan is given to you in the form of a smart contract, which is like a program on a computer that works on its own. You then pay back the loan with interest, and the smart contract automatically closes.

The important thing to note here is that there is no bank or other financial institution involved. The whole process is automated by smart contracts, and it all happens on the Ethereum blockchain.

What's also interesting about MakerDAO is that it uses a system of collateral to ensure that the Dai you borrow is always backed by real assets. In other words, if you want to take out a loan in Dai, you need to put up some other cryptocurrency as collateral.

This system of collateral is what's known as a "collateralized debt position", or CDP for short.

It's arguably one of the reasons why defi protocols have held up so well against centralised finance. They don't use unsecured loan formats which means less exposure to risk if someone can't make their repayments.

You may be thinking why even use a Collateralized Debt Position? Why borrow the money you have already?

There are several reasons why you might want to use a collateralized debt position.

First, it allows you to borrow money without having to go through a bank or other financial institution. This can be helpful if you don't have good credit, or if you want to avoid the high fees that banks charge for loans.

Second, it allows you to use your cryptocurrency as collateral to get a loan in fiat currency. This can be helpful if you need cash but don't want to sell your cryptocurrency.

Third, it allows you to get a loan in Dai, which is a stablecoin that is pegged to the US dollar. This can be helpful if you want to avoid the volatility of cryptocurrency prices.

Fourth, it allows you to use your cryptocurrency as collateral to get a loan in another cryptocurrency. This can be helpful if you want to diversify your portfolio without selling your existing holdings. I could go on.

So, that's the story of MakerDAO and a small taste of how its lending works and why you would use it.

Now, let's take a look at another growing defi protocol to knock investors off their armchairs - Uniswap.

Uniswap is a decentralised exchange, or DEX for short, built on the Ethereum blockchain. It allows you to trade cryptocurrency without having to go through a centralised exchange like Binance or Coinbase. Or a stockbroker on Wallstreet for that matter.

Instead, Uniswap uses smart contracts to match buyers and sellers directly. Thus cutting out those pesky middlemen. A simple yet very effective DeFi platform.

The stories of MakerDao and UniSwap give us a sneak peek into how DeFi can work. The tools are there to be used and it is ultimately up to you to use them. So go out and try out different DeFi protocols and see how they work! (Just make sure you do your research first).

ps - leave a comment for a more in-depth defi article