My intention with this post is to try to clarify all the aspects that surround this great explosion called DeFi, from the most basic concepts about finance to the structure of the current great protagonist of this article.
Lets start by the beginning.
What is Finance
Its the study of the circulation of money between individuals, companies or different states. Thus, they appear as a branch of the economy that is dedicated to analyzing how funds are obtained and managed. In other words, finances take care of money management.
We understand management as the action of making investment, saving and spending decisions under conditions of uncertainty. Now that we know a little more about what finance is, let's better understand the term decentralization or decentralized.
What is Decentralization
Its the process of distributing or dispersing functions, powers, people or things outside of a central location or authority. In other words, we could indicate that decentralization is the process of distributing and dispersing the records of economic transactions outside of a central authority or server.
Now let's include the context of Blockchain Technology, which allows us to develop applications whose codes (Smart Contracts) are distributed in a computer network, without a central authority that controls it, and create digital assets of which you maintain control.
So, we could conclude that DeFi is a term that groups together companies, which provide services that allow you to manage (make investment or saving decisions) your money on a platform distributed in a Blockchain Network, in which you control your funds.
So, would DeFi be the new financial system to replace the traditional one? Strictly speaking, DeFi would be a subsection of applications related to finance and money built on a blockchain, public and open network, such as Ethereum. Specifically, it would be a new financial system based on a distributed, decentralized, and censorship-resistant network. This new system would allow activities such as debt, credit, capital markets, money, store of value, investments and more, without a central authority associated with the traditional banking system.
Unlike the traditional system, these DeFi applications can work together, that is, interoperable (connect with each other like laymen), offering global services, without barriers, simple and easily accessible for people. This last description is what makes Bitcoin just a form of decentralized money or value, which in fact could be part of DeFi, but that the little possibility of creating applications and much less interoperating between them is what leaves it very limited in its developing. Lightning Network, which is a payment network, is included within DeFi. More about the Lightning Network, you can read my related post here.
What are the main fundamentals of DEFI?
- Open source and interoperable
- Accessibility and financial inclusion
- Financial transparency
Given the above, DeFi is a new financial system that is currently being built. Complementary to Bitcoin which is a new economic and monetary system.
What services can I access in DeFi?
Currently it is possible to access interests, options and derivatives, I can request fund loans, exchange tokens, among more than 40 applications or platforms that allow it.
You can review each of them at defipulse.com, an open platform that groups these applications within this ecosystem, and which could be like a kind of app store of applications based 100% on DeFi.
On this platform you can view a ranking that is ordered mainly by the amount of collateralized assets they have in their respective smart contracts.
The top 10 of these applications show us the following:
In total, there are 5 classifications that are given to DeFi platforms:
- Lending. They allow you to request the loan of a cryptoactive, leaving another as collateral.
- DEXes or Decentralized Exchanges. They allow you to exchange crypto assets for others directly with your wallet.
- Assets. They allow you to generate or represent real assets in tokenized assets to later be traded or exchanged.
- Derivatives. They allow you to access assets leveraged on other types of assets, such as futures of a particular crypto asset.
- Payments. They allow you to access payment protocols such as the Lightning Network on Bitcoin.
Within this ecosystem we have known new financial terms, within which we can mention:
- Yield Farming: It is an activity carried out by users (investors, traders) who own cryptocurrency assets and use these to invest them and obtain the highest possible return on their investment. They look for opportunities on the Internet to commit their crypto assets in making loans to other users, or to request loans from other users who make a living in the crypto assets trade, on the platforms that offer these possibilities. All of this translates into Yield Farmers being able to earn a profit in the form of interest earned on the amount of crypto assets that are deposited on the platform. And also, in DeFi you can receive implicit governance tokens to this platform.
- Liquidity Mining (mining pools): Mechanism by which the users of a protocol can provide liquidity in crypto assets and leave this liquidity blocked in a smart contract that is part of a DeFi project. It is a way of encouraging the community to participate in these projects by creating a liquidity market that allows offering financial services to other users.
- Staking: You can imagine staking as an alternative to mining that requires a smaller amount of resources. It consists of keeping funds in a cryptocurrency wallet, to support the security and operations of a blockchain network. Simply put, staking is the act of depositing cryptocurrencies in order to receive rewards.
What has been the impact of DeFi?
At todat, there is $ 9.27 billion dollars blocked or collateralized in these smart contracts, according to the platform defipulse.com
You can appreciate, this amount of collateralized assets has been growing for a long time. During 2019 the figure was around $ 500 million dollars, and in February of this year it exceeded $ 1,000 million. This last month its growth has really been exponential.
What is its potential?
The truth is that there is a lot of potential, considering that the traditional financial system cannot interoperate, that is, to access the services of a particular bank you must be a customer of that bank, and if there is another that offers other services, you must be also customer of that bank, and so on. In this ecosystem it is possible to operate with multiple services only with your wallet or wallet, without the need to be opening accounts in each of them. In addition, these same services can be connected to offer you more sophisticated services.
The potential of DeFi is tremendous, but very limited at the moment due to the low scalability that exists of Ethereum, the main network that is being used for the development of this ecosystem. It is time to see if these projects have the possibility to develop on other networks or wait for the growth of Ethereum 2.0.
I hope this post is useful to you, and remember: read, learn, enjoy, follow me on my new Twitter (or the less important one: tip me if you liked it)... and with or without DeFi, be happy!