What is DeFi?
Decentralized finance, or DeFi, is a new and exciting development and ecosystem of financial applications being built with blockchain technology without any intermediaries like banks. DeFi is part of the larger decentralization movement promoting transparency, open-access, and non-custodial global financial products.
At the time of writing, more than $100 Billion USD has been deposited into DeFi, and many renowned financial commentators believe it may soon eat Wall Street.
Navigating the world of DeFi can be challenging – with new projects surfacing week by week, it can be hard to keep up. Allow us to guide you through the ins and outs of DeFi from developing DAOs to understanding the wild world of yield farming where the community converses via mostly memes.
Why DeFi?
Since the 2008 financial crisis, where poor decision makers and financial regulators crashed the world’s economy, all kinds of communities across the world have lost faith in traditional financial systems.
From investors to day traders and unbanked families in developing countries, a variety of communities across the globe have been forced to find new ways to access money. In most countries, simply holding your own money in a bank account will cause the value of your money to decline.
More recently, the Robinhood and Wall Street Bets fiasco in February 2021 saw traditional finance become disrupted as young social-media fuelled groups joined together to stand up against legacy institutions and hedge funds. People have had enough.
Now, individuals around the world are seeking alternative stores of value for their fiat currency. As trust in our legacy financial institutions decreases, new innovations in decentralized finance provide a lucrative and more logical option that amend deep-rooted problems in our traditional financial systems.
How does DeFi work?
DeFi projects are built on-top of a blockchain, often the Ethereum Blockchain. It should be noted that projects are quickly expanding to other chains in the ecosystem. This is often referred to as “cross-chain building” or being “chain agnostic”.
DeFi protocols are permissionless and global. This ensures that these cutting-edge tools to increase savings and make payments and transfers, are accessible to anyone with an internet connection, anywhere in the world. No one individual, or institution, has control.
DeFi runs on distributed networks which allow users to maintain control over their assets and information. Because it is decentralized, there is no “off” button. Unlike the recent saga when Robinhood suspended user trades amid a buying frenzy, DeFi protocols have no central authority which could pause trading.
For the first time in history any individual can own a piece of the network and applications they use by purchasing a token that holds a portion of the project’s value. Users who purchase tokens early on may benefit if and when the value of the token increases due to the project’s success.
As opposed to the traditional financial system where company stock options may only be available to a select few, DeFi opens a new era where anyone with an internet connection can participate in lucrative decentralized money markets.
What is a Decentralized Exchange?
In order to understand the significance and importance of a decentralized exchange (DEX), we must first touch on centralized exchanges (CEX). CEX’s are trading platforms that function similar to a traditional brokerage or stock market where they are owned and operated by a company that maintains total control over all transactions.
Users of CEX’s do not have access to the private keys of their exchange account’s wallets. When you purchase digital assets through a CEX you put all of your trust in the hands of the exchange, where transactions can only be made through the central authority.
A decentralized exchange (DEX) is a peer-to-peer (p2p) online service that allows direct cryptocurrency transactions between two parties, without the use of a middleman. Unlike a CEX, a DEX is not operated by a company – it runs by utilizing blockchain (distributed ledger) technology.
DEXs do not hold customers’ funds or information, and only serves as a matching route for orders or trades. In the decentralized finance world, every address has a wallet where payments are routed. This creates a pseudonym to give the user a layer of privacy.
DEX’s offer independence from regulators while increasing security because they do not store user’s information.The absence of a central structure also lowers the chances of manipulation inside of an exchange.
What is a DEX Aggregator?
DEX aggregators pool liquidity from different decentralized exchanges to offer users better token swap rates than they could get on any individual DEX. A swap between several DEXs can get a user an overall better price than a swap on any single exchange. The user can conduct all of their business through one DEX, rather than having to use multiple platforms.
One of the most popular DEX’s is Uniswap, and new DEX’s are popping up every few months. Brave, a crypto native web browser, recently announced plans to integrate a DEX aggregator and NFT wallet into their next browser.
What are DAOs?
A DAO, or a Decentralized Autonomous Organization, is an organization with no CEO or board of directors, operating autonomously without a form of central authority. DeFi is a great use case for DAOs, as fully-fledged financial protocols can be built without a CEO or board of directors, allowing the community to be in charge of decision making.
DAOs are usually operated by a community who are incentivized via a governance token used for voting on the future of the organization.
Rules, decisions and actions of a DAO are collectively made by the community who make a vote. DAOs have no hierarchy, unlike traditional organizations. Once rules of the DAO are deployed, it cannot be controlled by one single entity but by participants in the network.
An example of a DAO is GnosisDAO, which is a prediction market platform. Using their governance token GNO, the GnosisDAO makes decisions based on the consensus of the community, building tools that optimize frictionless user participation. To participate in the DAO, members must hold at least 1 GNO and can participate in forums to submit and vote on proposals which shape the future of the DAO.
What is Yield Farming?
One of the most rewarding executions of DeFi technology is yield farming. In yield farming, users deposit cryptocurrency and effectively “lend” their crypto to earn interest by allowing others to access it. Yield farming offers higher yields that traditional banks have ever offered.
The rewards in yield farming are much greater than traditional investments, but there are a number of risks associated with yield farming. Volatility in crypto assets, high gas prices, and frequent attacks on DeFi protocols are some of teething risks of this new space.
Harvest Finance for example is a yield farming aggregator where individuals can access high interest pools and stake their crypto for rewards. Users can access Harvests vaults through a MetaMask wallet (a chrome extension) and deposit their crypto into automated farming pools.
What are Prediction Markets?
Prediction markets are mechanisms for people who are speculating on the outcome of an event. Prediction markets use smart contracts and blockchain voting mechanisms to verify and record the predictions and outcomes, and people wage crypto against the outcomes of events.
These events can include elections, the weather or more simply cryptocurrency movement predictions.
PlotX is an example of an Ethereum based, non-custodial prediction market which allows users to predict the future value of digital assets like ETH, BTC on hourly, daily, weekly, or any other time window. Users use their governance token, PlotX to wage their votes on the outcome of future events.
What are Data Oracles?
A data oracle is a way for a blockchain or smart contract to interact with external data. Oracles feed data from real world systems to the blockchain. In the world of DeFi, smart contracts are constantly trading, buying, and selling assets, so each protocol must be in consensus on things like prices as they change in real time.
Oracles act as a bridge, verifying external data through web APIs or data feeds. They digest external information into a format that a blockchain can read in order to execute conditions. Data may include weather information or sports data for example. If the conditions are met, the actions on the smart contract are executed.
With smart contracts, execution occurs when specific conditions are met, and data orales allow these smart contracts to run knowing that the data is being verified through the oracle.
For example, Band Protocol is a cross-chain data oracle platform aggregating and connecting real-world data and APIs to smart contracts. They help companies apply smart contract applications such as DeFi, prediction markets and games that can be built on-chain without relying on the single point of failure of a centralized oracle.
What are DeFi Legos?
DeFi Legos, also referred to as money legos, allow DeFi transactions to be more strategic than the basic “send and receive”. The core idea of DeFi legos is allowing you to stack various DeFi protocols in different formations for a combination of trades that can bring greater yield.
By programming logic and specific rules or conditions into a smart contract, users can perform a variety of acts building on top of one another. They are referred to as Legos because you can stack applications, incorporating things like lending, borrowing, and insurance all within one stack of applications. In DeFi, projects are designed to not only be used as a stand-alone product, but also easily integrated into the entire DeFi ecosystem bridging functionality.
What is Programmable Money?
Programmable money allows you to write code that automatically executes transactions within specific parameters using digital currency. It allows you to create a chain of transactions depending on the outcome of various events.
For example, you could program your app to say: “buy me $100 worth of BTC when the price hits $45,000, and then if it goes back up to $50,000, sell the $100 that I just purchased, or else hold the money”. Smart contracts allow users to program their money, walk away, and have the program execute the code without human interference.
An example of a programmable money app is Furucombo, which is a drag and drop DeFi aggregator that visualizes DeFi protocols into cubes, and allows end users to stack combinations of different trades and loans. This is a simplified way of stacking lending and borrowing applications, as it does not require code, and users can also copy successful pre-built combos from top traders.
Taking Your First Steps into DeFi
To step into the land of DeFi, you only need two things: a wallet, and cryptocurrency. MetaMask is a popular Chrome extension which allows you to trade, borrow, lend, and use your money on Web 3.0 websites – the third and “smarter” generation of the internet operating on the blockchain. Your MetaMask wallet connects your cryptocurrency to the smart-contracts that run DeFi apps, allowing you to access blockchain technology.
MetaMask looks similar to other Chrome extensions, but while using the application it will show you in real time as it processes transactions on a smart-contract during trades.
The future of the web and the vision of DeFi contains innovations that could open up opportunities for financial inclusion to a new population. Suddenly you don’t have to have a bank account in order to get a loan, and your currency can lend itself at a higher return rate for a steady flow of passive income.
There are endless amounts of opportunities to integrate our current internet and financial structure with DeFi in order to build better tools for all. Maps.me, which raised $50M for DeFi integration, is offering a service which integrates hotel bookings and travel guides into an interest-bearing cryptocurrency wallet for travelers. These types of integrations, merging Maps.me’s 160 Million user-base with a robust DeFi protocol offering economic incentives to users, shows how quickly this nascent technology can integrate into our everyday lives.
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YAP Global is an international Public Relations and Communications firm that works with meaningful fintech, blockchain and cryptocurrency projects, bridging quality journalism and emerging technology companies making a difference in the world.