Decentralized Finance, or DeFi for short, has taken the world of crypto and blockchain by storm. However, the root of the last revival is overshadowed by the 2017 bubble period. While everyone and the dog did the “Initial Coin Offer” or ICO, several companies saw a lot of the potential of blockchain to make a quick profit. These pioneers thought that financial applications from trade to savings, from banking to insurance, would simply be possible in a blockchain without any intermediaries.
To understand the potential of this revolution, imagine whether you have access to a savings account that earns 10% of US dollars a year, but without a bank and virtually no cash risk. Imagine being able to trade in product insurance with a farmer in Ghana sitting in your office in Tokyo. Imagine being a market maker and earning the interest rate that every Citadel wants. Sounds too good to be true? Not at all. This future is already here.
DeFi’s building blocks
Here are some basic DeFi blocks you need to know before proceeding:
Making a market without an intermediary or clearing house or unreliably exchanging one asset for another.
Excessive lending or the ability to “use your assets” for traders, speculators and long-term owners.
Fixed or algorithmic entities that track the value of a base without centralization or support by physical entities.
Understand how DeFi is prepared
Stablecoins are often used in DeFi because they mimic traditional fiat currencies like the USD. This is an important development, because the history of crypto shows how volatile things are. Fixed currencies such as the DAI are designed to track the value of the USD with small deviations, even in strong bear markets, where the price of the cryptocurrency will fall as the bear market in 2018-2020.
Lending protocols are an interesting development, usually based on stablecoin. Imagine being able to lock up your assets worth a million dollars and then borrow a fixed amount against them. If you do not repay the loan when you no longer have collateral, the protocol will automatically sell your assets.
Automated market makers are at the heart of the entire DeFi ecosystem. Without it, you are stuck in an old financial system where you have to trust your broker or clearing house or stock exchange. Automated market makers, or short-term AMMs, allow you to switch from one asset to another based on the stock of both assets in their pools. Price discovery occurs through external arbitrators. Liquidity is consolidated based on other people’s property and they have access to trading fees.
You can now experience a large number of assets in the Ethereum ecosystem and without interacting with the traditional financial world. You can make money by lending assets or by being a market producer.
This is an amazing innovation for the developing world, because now developing countries have all the financial systems that have no barriers to entry.