DeFi is the current trend in the field of cryptocurrencies. At the heart of the Ethereum blockchain technology. Includes various financial instruments, services, and applications. Covers almost all areas in the field of financial services – lending, loans, deposits. Peer-to-peer or decentralized applications are used to access the DeFi system and asset management.
Since 2019, decentralized finance has remained in trend and continues to gain in popularity. The main mission of DeFi is to replace or alternatively the real banking sector. Thanks to the services and applications of the decentralized finance ecosystem, interested users get access to low-cost loans and investment platforms. Moreover, operations are carried out without traditional intermediaries, saving on commissions, fees, and other payments.
Most of the DeFi services are based on the Ethereum blockchain. a. So, as of May 2021, the volume of Ethereum blocked in all DeFi applications is 88.66 billion US dollars. These data, as well as dynamics, are presented on the defipulse.com portal.
Features of Decentralized Finance
The main differences between DeFi and traditional financial services:
Traditional DeFi management methods don’t work. All the rules and features of the project are specified in the smart contract. After its launch, operator intervention is not required, all conditions of the contract (operations) will be performed automatically.
The code of any application is open, a simple user can check it for errors, understand the features of the functionality. The availability of DeFi applications is limited only by the user’s access to the Internet.
Anyone can create a decentralized application or service. This is also the difference between decentralized finance and traditional ones. To interact with the application, the user only needs to have a cryptocurrency wallet. There are no operators and controllers familiar with the traditional financial sector. The user can use any convenient interface, including from a third-party developer. Another difference of DeFi is interoperability – the ability to combine different applications.
DeFi’s main advantage is decentralization. No individual or organization can fully control a decentralized product. The entire ecosystem is controlled by a collection of users. There is no need for banks, courts, regulatory authorities.
Transparency of transactions, the absence of intermediaries is another advantage of decentralized finance. All this affects the cost of operations – commissions are minimal, there are no different fees. The margin between credit and deposit is much smaller than the real sector.
Thanks to smart contracts, you can set rules that will be strictly enforced at the level of the program itself. These rules are the same for all participants and remain unchanged throughout the entire duration of the smart contract.
The credibility of open source applications is higher. Any user with some experience can check the code, modify it, apply it in a third-party resource.
Areas of Using
Decentralized finance is represented in different areas of financial activity:
- lending, loans;
- asset management;
- decentralized exchanges;
- decentralized autonomous organizations;
- tokenization and a number of others.
Decentralized stablecoins with a cryptocurrency underlying asset are relevant. The popular service MakerDAO uses the Ethereum platform to issue the Dai stablecoin. The issuing smart contract accepts Ether or other ERC-20 based tokens. Thus, the Dai stablecoin is a debt obligation to MakerDAO, secured by collateral. The service also releases the MKR stablecoin, which is used to pay commissions for smart contracts.
Loans are an in-demand application for DeFi. This area is actively developing and in demand. Its advantages are the absence of intermediaries, trustees. Reduced transaction fees, counterparty risks are minimized. The time of the operations is minimal. At the heart are smart contracts based on Ethereum. The main market operators are MakerDAO, Aave, Compound, Fulcrum, and others. The first three services are leaders in the DeFi Pulse rating in terms of the volume of blocked Ethereum (as of May 2021).
DEX is a decentralized exchange, another area of DeFi. Blockchain technology is at the core. In fact, it is a platform for communication between buyers and sellers. The exchange does not store the personal data of users, their savings. This is a new model for organizing trade, excluding the influence of a limited number of large participants. Many services perform several functions at once – asset exchange, loans.
Markets of prediction – the ability to place bets on various events. At the same time, the probability of events by platforms is determined based on the opinion of a large number of people. This approach allows you to more accurately determine the likelihood of an event than the opinion of an expert in this area. The prediction platform also trades portions of the possible profit.
Decentralized finance is used to create synthetic assets (Synthetix), issue STO securities (Harbor, Polymath), in asset management (Melon), and in trading.
Disadvantages and Risks
One of the risks of decentralized finance is the volatility of underlying assets. When the price falls rapidly, assets are liquidated. There is a risk of high transaction fees. This is possible during a period of strong cryptocurrency volatility. To combat these risks, decentralized sites and services seek to create an excessive amount of assets, while the price decreases.
It is worth mentioning the risk of trusting the code. If DeFi eliminates the risk of trusting a person, then the smart contract code remains the weak link, because it is written by a person.
Oracle is a program of interaction between two worlds, real and digital. This is one of the most vulnerable spots for decentralized financial services. The malicious intent of the oracle will call into question the correctness of the implementation of the conditions laid down in the smart contract.
Some services are developed by a team, so control is held by a limited number of people. This is somewhat contrary to the principle of decentralization.
There is no specific body or person responsible for everything that happens. Under the condition of malicious actions of the participant or indifference to the development of the ecosystem, there are risks of system collapse, bugs.
The emergence of DeFi is a natural stage in the development of the digital asset market. Now the sphere of decentralized finance is at the peak of its popularity. Even if the hype dies down a little, DeFi will remain in demand, the potential of the ecosystem is obvious.