Today, one of the most promising and rapidly growing crypto industry segments is decentralized finance, or DeFi. They are becoming a way more accessible alternative to the most financial services people regularly use, e.g. crediting, insurance, depositing, investment and risk management.
Development of decentralized finance leads to destruction of the traditional model of the financial system that everyone had used to, despite all the drawbacks. But now, financial processes can be even more efficient thanks to smart contract-inspired automation. Intermediaries are not needed any more, and there is no room for fraud: all the transactions are transparent, verifiable and running autonomously.
Decentralized finance has been in the spotlight since the across-the-globe market collapse in March 2020, but most people still do not understand what this phenomenon is about. At first, DeFi was a common name of the analogues of traditional financial instruments that are implemented in a decentralized architecture. Now they have morphed into a widely-accessible ecosystem formed of decentralized services and applications powered by public blockchains, mostly Ethereum.
The purpose of decentralized finance is establishing a financial system that would be open to everyone and would not require user trust. A parallel goal is promoting the self-sustainability principle. Considered a disadvantage by conservatives, the latter principle cultivates responsibility for DeFi investments.
At first sight, decentralized finance seems similar to financial technology (FinTech) that is also aimed at modernising financial services. However, while FinTech is just based on a conventional financial infrastructure, decentralized finance includes a number of novel components.
Let’s recall a popular international payment service TransferWise. Though it charges way lower fees than most banks, it still employs bank accounts and other infrastructure elements (which are possibly outdated). What makes TransferWise unique is that the banking accounts opened in many countries across the globe hugely facilitate transactions. When you send euros to someone living in another country, a fintech service captures your money, and to the recipient, it gives the funds from the corporate account in the recipient’s country. This is how transaction processing gets many times faster and fees lower.
And now let’s compare the above model with a DeFi transaction—for instance, Dai. You don’t need to trust a fintech company or a bank with your money to transfer Dai. Instead of centralized intermediaries, ether miners verify new Dai transactions, and then include them into new Ethereum blocks. Miners will process your transaction for an amount equalling one US dollar, and this will only take around 15 seconds (the period required to create one block in which all verified transactions are recorded).
As a cherry on top, you can send your tokens (Dai in this case) to any person who has a wallet that supports Ethereum’s ERC-20 tokens. No matter where your recipient lives: even if they live in a sanction-covered or obsolete-financial-system country, they will get your tokens within 15 seconds.
Since decentralized finance is an accessible alternative to most traditional financial services, everyone who has an Internet connection and some awareness of cryptocurrencies, can interact with the DeFi ecosystem and manage the assets deposited therein. For that, blockchain developers have created a hundred new DeFi projects with their own unique protocols, peer-to-peer networks, decentralized applications (dApps) and services.
The earliest widespread DeFi use cases were stablecoin projects. Stablecoin is a cryptocurrency, the price of which is pegged to the price of a reference financial instrument (fiat currency, commodity, raw material). Thus, all the issued stablecoin units are backed by a reserve stored at a reliable custodian. The value of the USD-pegged stablecoins is ensured by the issuer, while their purchase and sale are subject to AML/KYC procedures.
Examples of DeFi projects with stablecoins: mStable USD (MUSD), sUSD (SUSD), Wrapped Bitcoin (WBTC). The latter, in contrast to dollar analogues, is pegged to the price of bitcoin, but is powered by the Ethereum blockchain.
There is another type of crypto projects, the most prominent of which is MakerDAO, a decentralized autonomous organisation (DAO) and the Ethereum-based protocol. MakerDAO has a native stablecoin DAI and allows issuing custom stablecoins via the DeFi protocol. Their issue is comparable to the issue of conventional currencies backed by gold, where the only difference is that ether is used instead of gold. A user sends several ETH coins or approved ERC-20 tokens to a smart contract that creates a new stablecoin. This is called collateralized debt positions: the created DeFi tokens are basically a collateral-backed debt payable to MakerDAO.
In 2021, decentralized exchanges (DEX) restored their popularity thanks to DeFi. They run on a blockchain and do not store users’ crypto and data on their servers. In fact, these cryptocurrency exchanges act exclusively as a platform that only brings together buy and sell calls. Such a trade model helps avoid KYC procedure and is not subject to the interests of a small circle of major traders.
Here are some peculiar examples of DEXs:
Peer-to-peer prediction markets have captured a unique niche and keep holding it. They are platforms that allow placing bets on various events, elections, etc. Actually, the purpose is kind of similar to sports betting, so the principle does not need much explanation.
Telling examples of prediction markets:
Apart from stablecoins, DeFi exchanges, and prediction markets, there are at least 8 fields of decentralized finance:
The following are good examples of decentralized finance, which are services and applications that have already been developed and operating in the aforementioned fields.
A platform where you can study 40 different DAOs before joining any of them. Moreover, it allows creating a custom DAO based on Moloch, an open-source framework. Daohaus aspires to be a thoughtful and intuitive service for DAO members and founders, and wants to reduce coordination expenses to zero.
A protocol based on Ethereum smart contracts, through which users lend and borrow DeFi cryptocurrency at interest. Supports loan of ethers and 21 types of tokens, including stablecoins. Creditors invest their tokens in the liquidity pool and borrowers choose the most suitable terms and then get an instant DeFi loan. Interest rates are floating in both cases, corrected every 15 seconds—in line with creation of new Ethereum blocks.
A decentralized insurance platform where users can create insurance products and cooperate with each other. Beside the platform itself, there are two layers: Generic Insurance Framework (smart contracts, microservices) and Decentralized Insurance Protocol (rules and standards of interacting with the framework). Etherisc’s mission is to make insurance accessible and totally fair—by virtue of transparency; and buying and selling insurance more efficient—by cutting operating costs.
A multicurrency cloud wallet with mobile apps, crypto asset management and coin staking functions, and a dApp store. Distributing assets to minimise risks, the service is designed for undisturbed investing. Supports 20 blockchains and over 700 tokens that one can transfer to other users without a fee.
A multicurrency wallet and a dApp browser with an intuitive interface that will be loved by any user, especially a newcomer. Supports over 1000 cryptocurrencies, coin staking, and multisignatures. Huobi team guarantees asset safekeeping, which is proven by a number of data security patents (including those related to isolation and encryption).
A payment gate that helps instantly buy BTC, DAI, DOT, ETH, STAKE, USDC with a debit card or a bank account. Roots for transparent financial activities, adheres to laws and regulations. For developers, it offers Ramp Instant SDK for integration with third-party services, desktop and mobile apps.
A network of decentralized marketplaces and communities based on Ethereum with the key goal to facilitate coordination of peer-to-peer markets and community management. For developers, it offers the framework d0xINFRA for creating DeFi marketplaces or communities with smart contracts and front-end libraries.
In 2021, DeFi projects capture people’s attention just like ICO did it back in 2017 and IEO in 2019. But why is there so much excitement around DeFi? What are this ecosystem’s perspectives and benefits for participants and organisers?
One of the main advantages of DeFi is pure decentralization. Even the fact that all the participants—rather than an exclusive team of executives—can manage a crypto project with smart contracts, is a very important thing.
DeFi opens the global economy to people who couldn’t use financial services before. In fact, some 1.5 billion people on the globe cannot access banking services; they have no bank account, no debit or credit card. Many factors may be behind this unevenness, but the main reason is that most unbanked people just do not have all the documents that financial institutions usually require. Also, it’s hard to get a decent credit score in some countries. In others, bank offices can be barely found beyond the capital.
Along with maintaining a stable price-quality balance, decentralized finance offers passive income from the owned cryptocurrency. There are many options: high-interest savings accounts, asset placement, etc.
In DeFi, it’s only you who can control your assets. Using decentralized services and organisations like MakerDAO, you have a 24/7 handle on your finance. No governmental official can unexpectedly ban you in a dApp, freeze your account, or confiscate your funds.
In DeFi, all information is open and available for familiarisation—helping every user to pick secure projects and services from home. If you need a loan in real life, you have to come to various creditors, compare interest rates—all to make sure the information you are provided with is credible and there are no hidden fees. It’s all different with DeFi: all the information as to lending protocols, such as Compound, is easily accessible and transparent.
And here are the benefits that businesses can get from DeFi:
Need a DeFi solution? Feel free to reach us. Polygant will create for you a solution of any complexity: from a stablecoin to a DeFi app or DeFi platform. You only need to contact us to start. And then, during a personal conversation, we will discuss all the nuances and consult you on any aspect, after which we’ll get down to developing your project.