his tutorial will touch upon the main points on decentralized finance: what it is, what they are for, where they are used, what is yield farming, what are the advantages of DeFi, what are the disadvantages, etc.
What is Decentralized Finance (DeFi)?
Were all aware of traditional financial products and services. However, since the emergence of blockchain technology, the concept of Decentralized Finance, aka DeFi, has been on the rise.
Decentralized Finance (DeFi) is a decentralized, open source and trustless ecosystem of financial applications / services based on public blockchains, predominantly Ethereum. The DeFi ecosystem encompasses all aspects of financial services and transactions, including lending, lending, and trading within decentralized structures. Any Internet user can interact with the ecosystem and manage assets through peer-to-peer (P2P) and decentralized applications (dApps).
Bitcoin and Ethereum are the original DeFi applications, both managed by large networks of computers, and not a central authority. Due to its flexibility, Ethereum is the most common platform for the development of DeFi applications, but its not the only blockchain network.
Why is the DeFi ecosystem needed?
If Bitcoin is a peer-to-peer electronic money system, then DeFi is a peer-to-peer electronic financial instrument system. The ecosystem of decentralized finance can provide anyone with access to traditional financial services, eliminating the need for intermediaries and lowering barriers to entry.
DeFi applications and services are potentially useful for residents of countries with underdeveloped or unstable economies. DeFi services are also in demand in developed countries, especially in the field of lending, investment and the development of new models of income generation.
Alex Pack, managing partner at Dragonfly Capital, says, The goal of DeFi is to reconstruct the banking system for the whole world in this open, permissionless way. DeFi gives easy access to financial services, especially to those who cannot use the current financial system.
What are the key features and benefits of DeFi?
We know that traditional finance is dependent on institutions like banks to act as intermediaries, and courts for arbitration. And as mentioned previously, DeFi applications eliminate the need for these middlemen. Since it is based on blockchain technology, DeFi benefits from many of its features.
1. Autonomy - The digital assets and money that you own in the DeFi ecosystem belong to nobody but you. No central authority with the power to freeze your account, seize your assets, or block your transactions is involved.
2. Accessibility - An open ecosystem like DeFi provides ease of access for individuals who otherwise wouldnt have access to any financial services whatsoever. The services of traditional finance systems are usually unaffordable for low-income communities since they rely on intermediaries earning profits. However, DeFi is significantly cheaper, providing a range of financial services, and making them affordable for low-income groups and individuals.
3. Transparency - A decentralized network makes data available for everybody, eliminating most opportunities for fraud. Such a system helps in keeping service providers honest. You can easily find out the reserves of a DeFi bank, look up accurate loan rates, and also keep tabs on transactions of public figures if you can find their public address.
4. Tradability - Another attractive feature of DeFi is synthetic assets or tokenized assets. It allows you to trade efficiently without having to commit to an entire high-priced investment at once. You get the opportunity to purchase or sell just a portion.
Furthermore, through tradable tokens, which represent just a portion of a real estate investment, you can create investment opportunities for people who couldnt initially afford it.
5. Transboundary - Most DeFi applications are available to any internet user.
6. Inclusiveness - The DeFi ecosystem is inclusive - anyone can create and use an app. Unlike the traditional financial sector, there are no controllers and accounts that require complex forms to be filled out. Through wallets, users interact directly with smart contracts.
7. User experience flexibility - The DeFi ecosystem provides a flexible user experience. If the user does not like the interface of the application, he can use a third party interface or create his own. Smart contracts are like an open API that anyone can build applications for.
8. Interoperability - New DeFi applications can be created by combining other DeFi products (stablecoins, decentralized exchanges, prediction markets, etc.). This feature of DeFi resembles a model in which a certain structure can be assembled in various combinations.
Use-cases of decentralized finance
Decentralized Finance is a broad term encompassing a decentralized permission-less financial framework. As a result, we see various customer-oriented services packaged inside.
1. Borrowing/Lending - Open lending platforms allow you to lend cryptocurrencies and receive interest, as well as borrow cryptocurrencies and pay interest. It is one of the most popular applications of DeFi. It works just like a bank, except here, the smart contracts determine the loan terms, connect lenders to borrowers, and oversee the distribution of interest. Thanks to the transparency of the blockchain and the absence of an intermediary, the lender earns higher returns and better comprehends the risks.
The open lending protocol is built on a public blockchain network such as Ethereum, helping in the global adoption of digital assets. There are several advantages to an open lending protocol over the traditional financial system:
- Integration with digital asset lending or borrowing
- Ability to collateralize digital assets in case of loan default
- Quick transaction settlement and safe lending techniques
No credit checks, giving access to more individuals who cannot afford traditional financial services.
You can view the Borrowing / Lending list here: https://defiprime.com/decentralized-lending
2. Stablecoins - Stablecoins are cryptocurrencies whose value is tied to an underlying asset (such as the US dollar). Stablecoins are backed by fiat currencies, baskets of currencies, cryptocurrencies (such as ETH), physical assets (such as gold), or a combination of these assets.USD-backed stablecoins are effectively the right to claim fiat collateral from a centralized vault. The value of dollar-pegged stablecoins is provided by the issuer itself, and their use is often associated with AML / KYC procedures. There are already known cases when accounts of stablecoin holders were frozen and closed.
DeFi applications focus on financial services, including monetary banking services. Stablecoin mortgages, and insurance are common aspects of these services. As the crypto market continues to grow, stablecoins have also gained significant attention. In a blockchain ecosystem, stablecoins are virtual currencies that are pegged to a fiat currency. Decentralized stablecoins could potentially offset the volatility of the crypto industry as theyre pegged to physical currency and can be used as digital cash that is not controlled by a central bank.
You can see some descriptions of stablecoins like MakerDAO and Dai here: [GUIDE] Stablecoin Economy
DeFi stablecoins can be viewed here: https://defiprime.com/stablecoins
3. Decentralized Trading(DEX) - This involves decentralized exchanges, which enable you to trade cryptocurrencies on a distributed network without the interference of a third party, or anyone taking custody of your funds. This application of DeFi is a bit challenging, as it has a huge scope for financial innovation. Decentralized exchanges usually have lower trading charges compared to centralized exchanges, since they need less maintenance work.
Decentralized exchanges offer a new model for trading and exchanging assets, eliminating KYC procedures, dependence on one intermediary and oligopoly (a market with a limited number of large players).
You can find a complete list of DEXs in my guide: [BIG LIST] Buy/Sell Crypto (OTC, P2P, DEXs, CEXs, NO-KYC, ATMs, etc.)
In the table of contents under paragraph 4.
4. Non-custodial landing protocols - One popular use case for DeFi is borrowing without a trusted party or intermediary such as a bank or corporation. Non-custodial landing protocols use smart contracts to mitigate counterparty risks and lower transaction costs.
MakerDAO is one of the first applications of its kind. Following MakerDAO, other protocols appeared - Compound, Fulcrum, Aave. When choosing a protocol, one should take into account not only the size of the interest rate, but also other factors, including the risk of certain smart contracts, loan security and pool liquidity.
5. Peer-to-peer prediction markets - Prediction markets are platforms that allow you to bet on the outcome of events, games, elections, and more. Many jurisdictions prohibit gambling and betting on certain events, including elections, sports, court proceedings and other controversial events. Forecasting market platforms and applications rely on the wisdom of the crowd to determine the likelihood of a particular outcome. The data of modern scientific research support the notion that a large number of people ("crowd") always predict the consequences of certain events with greater accuracy than individual experts.
Augur is a platform for creating peer-to-peer prediction markets where anyone can place bets. The Augur protocol allows you to buy and sell shares of a potential profit.
5. Synthetic assets - Currently, protocols are being created to issue synthetic assets and derivatives through smart contracts. UMA (Universal Market Access) develops a derivatives platform to provide financial products with standardized contracts.
The Synthetix team is developing a protocol that allows the creation and release of synthetic assets.
Synthetix for beginners is described here: Synthetix for Beginners
6. Platforms for the issue of tokenized securities (Security Token Offering) - Tokenized securities issuance platforms decentralize the process of issuing or creating securities, which in traditional finance requires intermediaries such as investment banks. The equivalent of the securities market in the DeFi sector is the market for tokenized securities (security tokens). STOs imply the issuance of digital assets in full compliance with legal requirements, which provides a higher degree of protection of investor rights and a decrease in regulatory risks for issuers.
If during the ICO participants are usually offered utility tokens, then in the case of STOs, tokens are issued that have properties of securities (security tokens) and meet the requirements of securities legislation. They are usually backed by assets or the right to receive a portion of the profits of the issuing company, can be an investment, debt, derivative or digital portion of an asset and, as the name suggests, are generally recognized as securities.
The advantage of security tokens is the ability to divide the underlying asset into small units, which makes it more liquid and accessible to investors (fractional ownership). For example, instead of investing in the purchase of an apartment for subsequent lease, an investor can buy a token representing a share in such an apartment and giving the right to receive a proportional part of the income from its lease. Moreover, despite the low liquidity of real estate as an underlying asset, the liquidity of tokens can be high.
Today, there are a number of platforms that provide users with tools for issuing tokenized securities, validating subsequent transactions, an interface and functionality for interacting with investors and conducting corporate events such as buyouts, dividend payments, voting, etc. (Polymath, Tokeny, Harbor, Securitize) ...
7. Asset Management - While the asset management segment in the DeFi sector is comparatively small compared to that in traditional finance, there are a number of projects offering decentralized solutions, such as Melon. Its users can manage their own and others' assets in the form of ETH and ERC-20 tokens.
The Melon Protocol is also decentralized - it is administered by the community, not the board of directors.
Another investment solution is Set Protocol, which allows the creation of Sets, ERC20 tokens representing a set of underlying assets. This model is reminiscent of investing in ETFs in traditional finance.
A list of Asset Management tools can be found here: https://defiprime.com/assets-management-tools
8. DeFi escrow - Arwen is an example of a DeFi escrow project. An Arwen user can trade on centralized exchanges without placing funds on them. Arwen enables traders to securely access the liquidity of centralized exchanges. At the same time, users have no reason to worry about the threats of hacker attacks.
What are the disadvantages and risks of DeFi?
1. Systemic risks - Systemic risks in the DeFi sector are liquidity and credit risks. Another problem with DeFi systems using cryptocurrencies as collateral is volatility. If the price of the underlying assets locked in the CDP falls rapidly, massive asset liquidation occurs and the system may collapse. Currently, to mitigate these risks, DeFi protocols are mainly trying to provide loans with excess assets, which has a downward impact on the price of these assets.
2. The risk of hacking smart contracts - While working with smart contracts in DeFi eliminates the need for human trust, there remains a need to trust the human-written smart contract code.
3. Centralizing data flow - Blockchain protocols extract data from the outside world using oracles. If the oracle acts in a malicious manner, the correct execution of the smart contract will be at risk. Centralized data oracles are a vulnerability for DeFi as well, although decentralized alternatives have already been developed.
4. Lack of capital in DeFi loans - Despite its merits (inclusiveness, etc.), DeFi loans are inferior to loans in the traditional finance sector, since the amounts that can be obtained with appropriate collateral are relatively small.
Monolithos experts on the advantages and disadvantages of DeFI
Advantages:
- The main advantage of DeFi services is hidden in the name itself. Decentralization. Thanks to it, control over the ecosystem is evenly distributed among many players. There is no excessive regulation, transactions are transparent, fast execution, there is no long chain of intermediaries. This is convenient, for example, when lending. There is no intermediary bank, which means that the one who gives the loan does not have to share the profitability with the bank, which accepts deposits at one interest rate, but issues loans at a much higher rate. There is no such gap in DeFi lending.
- DeFi services are governed by smart contracts and voting. Smart contracts allow you to establish the rule of law in the ecosystem, to create clear rules of the game.
- Open source. As in the case of the blockchain itself, services using opensource protocols are more trustworthy: they can be verified, they can be modified, and can be used in other services.
Disadvantages:
- The boundaries of responsibility are too vague. Decentralized finance is finance where there is no specific authority responsible for what happens in the ecosystem. The main principle of DeFi platforms is decentralized governance, based on the assumption that all players in the ecosystem are interested in its prosperity and therefore will make decisions based on their (and in DeFi ecosystems, this means general) economic benefits. But that might not work. This is not only about openly malicious actions aimed at the collapse of the ecosystem or the seizure of control, but also about the reluctance of the ecosystem players to somehow participate in the development of the service. This is the case when indifference is equivalent to malicious action.
- Control over development is in the hands of one team. This disadvantage is not common to all DeFi services, because many platforms involve collaborating with users on improvements, but many face it. In particular, problems arise when the responsibility is delegated to the community.
- Hype around the DeFi market. Any hype plays both to help and against the market. An overheated market will burst sooner or later. The situation is very similar to the 2017 ICO bubble. On the other hand, if you follow the well-known Gartner chart, then the bubble will be followed by a fall, followed by a smooth growth and real application of technologies.
Where to track the main indicators of the DeFi sector?
- defipulse.com - the amount of funds blocked in DeFi protocols.
- defimarketcap.io - Market capitalization of DeFi protocol tokens.
- defiprime.com - Interest rates in DeFi protocols.
- [urldefiprime.com=]defiscore.io[/url] - risk assessment of DeFi protocols.
- dappradar.com - Data on decentralized applications.
What is yield farming in DeFi?
Yield farming) is the process of obtaining native tokens through any form of interaction with DeFi protocols. For example, for providing liquidity to lending protocols or decentralized exchanges (liquidity mining), as well as for obtaining loans and participating in voting. Read more at the link.
In theory, such encouragement is intended to stimulate user activity, but in practice it leads to market manipulation, reminiscent of the ICO bubble in 2017. A good example is the YFI token from the Yearn Finance project, which has grown from $ 35 to $ 4,500 in just a week since launch.
You can read a short history of yield farming in my guide, and there I also publish fresh guides on token farming and earning profitability on a daily basis: [DeFi] Yield Farming Guides
Useful Links
Besides the links above, I would add the following for newbies:
- [BIG LIST] DeFi Projects & Tokens - My big list of DeFi projects, there you will find projects in many categories.
- [HUGE LIST] Useful Crypto Links !!! - This topic has a huge number of links, including to decentralized finance, in the table of contents at number 77
- [BIG LIST] Crypto Assets for Staking + Staking Providers !!! - This thread has a large sheet for staking assets, including DeFi.
- https://landing.coingecko.com/how-to-defi/ - CoinGecko's Defi book for beginners
Sources:
- https://hackernoon.com/a-n00bs-guide-to-decentralized-finance-defi-sa2a3xsw
- https://yandex.ru/turbo/forklog.com/s/testovaya-izolyatsiya-runeta-sorvalas-vtoroj-raz/