The general aim of cryptocurrency is to make money and payments peer-to-peer and universally accessible irrespective of a person’s location. The Decentralized Finance (DeFi) or Open Finance ecosystem takes this aim a step further. Imagine a complete financial system where payments, savings, loans, trading, insurance are more accessible to everybody that uses a smartphone and has an internet connection in the world. This is what defines the DeFi ecosystem!
Several interacting financial applications constitute the DeFi ecosystem. These applications consist of complex, closely related services, markets, payment tokens, derivatives, decentralized exchanges and platforms intended to provide efficient and regular financial services that operate independently without a centralized authority. For instance, an investor in the DeFi ecosystem can lock his funds in smart contracts and earn interest in a transparent, accessible and without any third party involvement. He can also decide to unlock his funds anytime he wishes to, without asking permission from anyone.
You may already know ethereum and other cryptocurrencies that aim to provide decentralized payments for goods and services. But these cryptocurrencies are vast, open source networks that allow anyone to create an application that enables a financial activity such as borrowing a loan without the involvement of a centralized institution. For instance, you can develop an application on ethereum blockchain that allows the exchange of funds between lenders, investors, and borrowers. An application of this nature is called a decentralized application (DApp) or product in the DeFi space.
The DeFi ecosystem therefore comprises a group of decentralized applications or products that work together to provide users with a decentralized financial system in perfect sync with traditional finance. In a decentralized financial system, one can send/receive money, borrow, lend, invest, exchange etc with complete freedom. That’s, without trusting or asking permission from anyone to do so.
The DeFi ecosystem is growing in a blossom speed with the total value locked in DeFi surged past $850 million. Several products have been developed in DeFi and a flurry of new products emerge in every single day due to the attraction this movement is getting in the crypto space.
DeFi products have been classified into several groups. This section of the article will look at some of the DeFi products and their uses in the industry. Let’s go through some of these products.
Open Lending Protocols: Just like a bank that gives loans, open lending protocols in DeFi allows a user to deposit money in a smart contract and when someone else borrows it, he earns interest on his deposited money. However, unlike a bank where some people decide the loan terms, or distribute the interest and connect borrowers to your money, in DeFi, a smart contract does that. Due to the inherent transparency, security and automatization of the blockchain technology where these applications are built on, the lender has full control of his deposited money and earns higher returns and more clearly understands the risks.
Several decentralized lending platforms have been developed since inception. These platforms have probably become the most popular among other open finance products in recent years. There’re many open lending platforms in DeFi that provide loans to businesses, or the public with no intermediaries present. Some of them are MakerDAO, Compound Finance, Dharma, BlockFi, SODA, Aave, Coinloan, Constant, Ethlend, Fulcrum etc.
Decentralized Exchanges (DEXes): many exchanges have already existed in the cryptocurrency space. Some of them are coinbase, binance, hitbtc, etc. However, most of these are centralized in the sense that they’re being controlled by centralized companies or entities. For instance, an exchange like Coinbase stores your crypto for you and holds your private keys for safekeeping. Your account on this exchange can be frozen or terminated by the company in case of any situation.
Decentralized exchanges on the other hand have peer-to-peer transactions of digital assets with no third-parties involved. These transactions take place on a blockchain which’s transparent, decentralized and automated. The advantage of DEXes is that no one has access to your wallet or account and there are no sign-ups, no identity verification, or any withdrawal fee. Exchanging between digital assets is done with complete decentralization.
The popular Decentralized Exchange platforms (DEXes) include 0x, AirSwap, Bancor, Kyber, IDEX, Uniswap, Paradex and Radar Relay. All of these have slightly different architectural designs.
Stablecoins: the idea behind stablecoins is to provide some of the advantages of both fiat currency and cryptocurrency worlds. Stablecoins aim to correct the insane volatility with traditional cryptocurrencies whilst maintaining the other features of cryptocurrency such as peer-to-peer, transparency and secured transactions.
The most common stablecoin in DeFi is MakerDAO’s DAI Stablecoin. Unlike other centralized stablecoins, DAI is the only crypto backed stablecoin that relies on trustless issuance and maintains its 1:1 peg against digital assets through various methods including over-collateralization and incentives. It’s not volatile, and always maintains its price to one DAI to one dollar.
Decentralized Insurance Platforms: insurance companies exist in traditional markets to provide a guarantee of compensation in times of specific losses, damages, illness, or death in return for payment of a premium. But, there are many problems associated with these insurance companies such as lack of trust, manipulative rates, excessive politicization and many more.
Decentralized insurance platforms solve these challenges through smart contracts. An insurance company in the traditional financial system may fail to pay claims or offer some benefits because this is done by human beings. But in decentralized insurance, the smart contract performs exactly as programmed and activities on this platform are recorded publicly that no single person can manipulate the stipulated rates without the consent of the participatory parties. Some of the decentralized insurance platforms in DeFi are vouchForMe, Nexus Mutual and Etherisk.
DeFi products are proliferating. Lots of people around the world realize the potential abilities of this movement and join in every single day. Many decentralized products keep emerging to provide more financial services to people and also solve the numerous challenges that people face in the traditional financial system.
The article didn’t state all the decentralized applications in DeFi, other important sectors include marketplaces, prediction markets, derivatives etc. The summary of specific applications in various sectors can be seen in the image attached above.