DeFi - A Beginner’s Guide to Decentralized Finance

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DeFi (short for Decentralized Finance) is a blanket term used to describe the industry of financial services – payments, lending, trading and more – provided through decentralized platforms on public blockchains. As opposed to highly centralized traditional financial institutions, these applications (known as dApps) are not controlled by a single entity, which enables for higher transparency, safety and cost reduction. In February 2019, the DeFi industry exceeded $1 billion in assets locked in DeFi protocols by users.

Decentralized finance applications are typically divided into three categories – stablecoins (e.g., MakerDAO, Synthetix, EOSDT), lending (e.g., Compound Finance, Aave), exchanges (e.g., 0x, AirSwap, Bancor) – the majority of the services being interconnected and interoperable on the protocol level.

Comparative analysis of conventional and DeFi systems
Criteria Conventional systems Decentralized Finance
Trust source Financial institutions Public blockchains
Transparency Hidden data and content from clients Open and transparent
Flexibility Limited innovations due to licensing and authorization Public, decentralized
Intermediaries Multiple Zero (p2p)


Underlying features of DeFI

The majority of core features inherent to DeFi as a financial infrastructure are determined by the underlying blockchain technology.

Democratization and global availability

Decentralized applications (also known as dApps) for payments, lending, exchanges, and so on, are available to any individual that has access to the internet.

Currently, access to the majority of traditional banking services around the world is determined by a person’s occupation, location, and wealth, which leaves millions of people unbanked or unable to exercise their financial needs (e.g. international remittance or loans) due to high commissions or other limitations. Removing multiple financial intermediaries (DeFi transactions are peer-to-peer) results in significant cost reduction and leads to a democratization effect.

Just as well, DeFi services impose no restrictions or censorship, as they operate without third party interventions.

Programmability and transparency

Decentralized Finance enables for the fast and flexible creation of customizable financial services and assets. The code is transparent and visible for open auditing to discover bugs and issues within the code. This leads to the creation of strong communities around DeFi, as users tend to develop a keen level of interest and integration while working on improving the service.

On top of that, every transaction and interaction within a DeFi application is publicly available. Blockchain technology is, essentially, a distributed and immutable database, which ensures ultimate transparency and impossibility of financial and technical manipulations.

Anonymity and data privacy

Despite all transactions being transparent on the ledgers, each DeFi user operates privately and is not required to submit his/her personal information (name, age, location, etc).

The majority of blockchain-based applications allow users to carry out their financial operations while remaining completely anonymous, putting personal data privacy as the core priority.

Interoperability

Being highly customizable and often referred to as “Lego blocks”, DeFi applications are easily integrated with one another, creating a comprehensive ecosystem.

Blockchains used in DeFi

Ethereum

Distributed software platform released in 2015. As a blockchain and smart contracts pioneer, Ethereum received mass adoption as the underlying technology for the first dApps and the Initial Coin Offerings (ICO) wave of 2017. To date, ERC-20 standard and its variations remain the most widely used protocol for decentralized applications.

EOS

Created by Block.one in 2018, EOS has quickly made its way to top-10 cryptocurrencies by market capitalization. It is generally regarded as the main rival of Ethereum as the protocol for DeFi apps, as it offers alternative solutions to main problems inherent to Ethereum, such as scalability and transaction costs. EOS raised astonishing $4 billion during its initial coin offering campaign, becoming the largest ICO ever.

Tezos

Having become another largest ICO in 2017, Tezos was released in 2018. It offers its own approach the questions of governance, consensus mechanism, and the underlying programming language.

In 2020 Tezos made its entrance to the decentralized finance market, having announced the soon-to-be-launched decentralized autonomous organization StakerDAO.

Types of DeFi applications

Lending Platforms

Being the largest use case of decentralized finance by far with hundreds of millions USD in daily volume, decentralized lending platforms give businesses and individuals access to peer-to-peer borrowing and lending without any intermediaries involved, which results in cheaper loans.

Decentralized lending platforms allow cryptocurrency owners to leverage their cryptocurrency assets to support their loans, or to lend and earn passive income in a rather risk-free way.

Examples:

Compound Finance
Aave
MakerDAO
InstaDApp

Stablecoins

Stablecoins are cryptocurrencies backed by a reserve of traditional assets and/or underlying stability mechanisms, and pegged to the price of a particular asset (US dollar, EUR, gold, etc). Stablecoins are designed to minimize market volatility and keep the price stable at all times.

There are four main categories of stablecoins: fiat-based, commodity-collateralized, crypto-collateralized and uncollateralized.

Examples:

USDT (Tether)
PAX (Paxos)
TUSD (TrustToken)
DAI (MakerDAO)
GUSD (Gemini)
EOSDT (Equilibrium)

Trading

Decentralized exchanges enable peer-to-peer trading that does not require users to trust a third-party service to hold their funds.

Examples:

AirSwap
0x
IDEX
Bancor
Kyber Network

Payments

Decentralized applications that address areas of international invoicing and payments.

Examples:

OmiseGo
Request Network