The DeFi Fundamentals
The Heart of DeFi
Although it has been a little more than 10 years since the first real blockchain product creation, there has been a substantial technological and informational jump in the development of the crypto field during this time. In this fast evolving business, vocabulary and many concepts are still being formed and refined; completely new definitions emerge as a result of the emergence of a new trading field.
One of the blockchain evolutions is DeFi. Its ecosystem is expanding and evolving, with the goal of becoming one of the most important players in the world of bitcoin financing. Financial independence and the absence of intermediaries in major financial transactions are two fundamental characteristics that provide this sector exponential development potential.
What exactly is DeFi?
People can now refuse contacts with a throng of centralised intermediaries in the transfer of value, leaving the accounting operators (miner, block producer, and delegate) out of the equation. This has acted as a significant catalyst for the advancement of technology as well as financial connections. Transfers of tokens gained traction, and with the rise in the market's total capitalization, they rocketed into the modern financial world. Open tools or protocols in distributed systems that tackle some financial difficulties are referred to as DeFi.
Decentralized Finance (DeFi) is the most widespread use of tokenization. It's an ecosystem that's sprung up as a result of the proliferation of various blockchain-based financial apps. Decentralization of the traditional centralised financial services business is the goal of the DeFi movement.
DeFi is divided into various groups, according to analysts:
UniSwap, Kyber Network, Bancor Network, Ren, IDEX, and BitShares); Lending and Borrowing (MakerDAO, Compound, Dharma); Derivatives, Margin Trading, and Prediction Markets (Augur, CDx, dYdx, bZx, and Daxia); Liquidity Mining (SushiSwap, Pickle, Cream Finance, Core Vault, and others).
The capacity of protocols to interact with each other and with derivative tokens is a feature of DeFi development firm in a single distributed system. As a result, DeFi on the Ethereum blockchain has acquired the most traction.
DeFi Pulse is the source of this information.
However, something else is happening against the backdrop of blockchain integration services and tools: the existing financial sector is prepared to enter the market for distributed ledger systems. Hundreds of thousands of DeFi developers labour in numerous huge corporations to meet modern humanity's transfer needs. Development occurs in a variety of ways:
Insurances Identification
Patents for Metal Trade Clearing Houses
Crediting for Healthcare/Health Insurance
All of these are real services that are waiting for clients that are ready to enter the world of decentralised money.
Overview of Technology
DeFi is based on smart contracts, which are the finest blockchain technology application currently available. A blockchain is a decentralised database in which all records are sorted in a linear order into blocks. Furthermore, each successive block absorbs all of the prior block's information. To be able to add records (transactions) to the database, nodes (users) must have some effect, and the process of recording the database itself must utilise certain resources to assure the operation of all nodes.
Using coins and tokens for value exchange, blockchain technology ensures the security and continuous operation of a distributed network. As a result, cryptocurrencies (or tokens) are used to reflect the value of specific transactions created by users in a decentralised network, much like digitised fiat money. At the same time, in the blockchain product development system, the rules for organising money issues are always defined by the computer code of free software of a particular cryptocurrency, not by the government's or central bank's decision.
Analysis of the Technical
The DeFi apps are based on a collection of smart contracts, which govern the behaviour of assets in the ecosystem using "if this, then that" logic. Smart contracts do away with the need for centralised intermediaries, lowering the cost and time it takes to complete financial transactions. This technology makes operations so simple that centralised suppliers use it to boost their productivity.
Typically, the DeFi ecosystem is depicted and discussed as a series of layers. Opinions disagree on the number of levels and how they should be labelled, but it is widely agreed that the blockchain is the foundation layer (almost always Ethereum). The settlement layer, the asset layer, the protocol layer, the application layer, and the aggregate layer are the five layers that make up DeFi.
As a result, DeFi operates on a five-layer system. Each of these layers serves a distinct purpose:
The settlement layer is the one that lays beneath the blockchain. There won't be anything to create apps on without this base. It's a platform that's unlike anything else in the world of controlled finance: transactions are verified by miners and logged in the blockchain's distributed ledger. This one-of-a-kind feature, however, has a number of potential downsides in terms of transaction costs and transaction time.
Any token used in the DeFi application, including native protocol assets, has an asset layer (generally ETH).
The protocol layer contains the DApp's actual inner workings (decentralized applications). It usually consists of a set of smart contracts that regulate the behaviour of the assets in the DeFi environment automatically. It's important to note that, while all smart contracts are governed by their own logic and always work in accordance with that logic, they were created by people, and their code may contain bugs or loopholes that can be exploited.
The application layer provides a graphical user interface that allows users to interact with the DeFi platform easily. Only individuals who are really knowledgeable about blockchain and know how to programme will be able to interface with DeFi without this layer.
The aggregation layer is similar to the application layer in that it is an extension of it. Aggregators combine numerous programmes so that customers can do multiple types of DeFi transactions from a single dashboard. The aggregator could be made up of pre-built decentralised applications, but it's more probable that it'll make use of DeFi's "financial building blocks" and let users choose which decentralised apps to combine to create their own DeFi product suite. This is DeFi's strongest suit. DeFi as a whole can become more than the sum of its parts because of the level of aggregation.
A user can begin interacting with their decentralised applications by first installing their aggregator. They can use this dashboard to access any or all of the DeFi platforms they're currently using. Consider it similar to your phone's home screen, where you have different icons for your preferred apps.
DApps for DeFi
DApps are distinguished from traditional apps by the fact that they use blockchain as a database. DApps are utilised in a wide range of applications, including gaming, sharing disc space or computing power, markets, and social media. Decentralized finance, or DeFi, is one of the applications that can be used in this way. DeFi applications provide financial services in the same way that banks do, but without the bank's centralised management. The provision of financial services is a fully automated operation. Only users who possess the platform's management tokens can vote on changes to this process. For financial administration and security, DeFi DApps use protocols and smart contracts.
Two sorts of tokens are used in DeFi applications: a control token and a token related to the value of an asset. Control tokens are used to vote on application updates. Tokens linked to asset values are used for trade, interest accrual, and payment, or are issued as a liability for which the collateral can be repaid. They can be stablecoins that are tied to an asset at a 1:1 rate, or they can fluctuate in value in reference to an asset.
COMP and aTokens are used in the Compound DeFi protocol, for example. When a user provides a loan, the latter is given to him or her. The aTokens rate fluctuates in response to the loan's interest rate. As a result, when the user returns them, the exchange rate is reset. As a result, the protocol returns the collateral, as well as interest, to the borrower.
Providers of Liquidity
When they construct the DeFi project, they keep in mind that it will operate on the following concept. There are users that supply liquidity in the form of interest-bearing loans, which the protocol prohibits. Other consumers make benefit of this liquidity, for example, by taking out interest-bearing loans. Smart contract protocols automate these operations, which makes DeFi unique. To accept or grant a loan, DeFi does not require the approval of the other party - the procedure is automated, and only a few requirements must be met to conclude a transaction.
To get a loan, for example, you'll need to put up collateral worth more than the loan amount. This shields the protocol from the turbulence of the coin that serves as collateral. Another option to limit volatility is to construct stablecoins using DeFi protocols, which are backed by collateral in excess of the issue amount.
Benefits and Applications of DeFI
Traditional banks can fulfil all of the same duties as DeFi, but considerably more effectively and conveniently. Decentralized finance allows anyone to take out loans, open interest-bearing accounts, and trade without having to rely on centralised companies. Decentralized applications (DApps), which are often deployed on the Ethereum platform, provide services.
At the same time, you don't have to be an Ethereum expert to use them, though having a better understanding of the process helps. Traditional and decentralised finance can be compared using the following criteria: The payment and transfer system. A bank transfer from one country to another might take days and be expensive. There is also a complete absence of privacy. The cryptocurrencies that underpin DeFi's development efforts do not require intermediaries, and transfers are completed as quickly as feasible (on the Ethereum network, from 15 seconds, with a commission of around $0.02).
The advantages are obvious:
Availability. Banks place severe limitations on who can open an account and, more importantly, who can access financial services like lending. More than a half-billion people throughout the world do not have access to financial services. Defi will undoubtedly make their life simpler. To utilise an account, all you need is access to the Internet.
Decentralization vs. Centralization: What's the Difference? Banks are relatively safe in terms of storing funds, but they are not without risk. And the failure of a major bank will inevitably result in a global financial crisis. Decentralized organisations handle DeFi protocols, providing assurance that some persons will be unable to make decisions on their own.
Transparency. The average investor has no understanding how his money in a bank account is spent. In the case of DeFi, the source code of protocols built on public blockchains is totally available to all users and auditable.
what exactly is defiant?
Decentralized identification is one of the most essential capabilities provided by DeFi. In the long run, a DeFi development firm with a decentralised identity could offer an alternative for people who don't have access to traditional financial systems' capabilities. There are billions of individuals without an official ID around the world, and roughly half of women in developing nations do not have one. However, many of them own smartphones. As a result, once decentralised identification systems are operational in developed countries, they can be introduced as a breakthrough technology in developing countries, just as smartphones were.
Interoperability is a key feature of developing DeFi on smart contracts like Ethereum. Smart contracts from diverse financial applications can be assembled like designer pieces, similar to libraries of software modules. For example, if you want to add a tokenized asset trading option to your platform, you can do it easily by implementing a decentralised exchange protocol. You can even create completely unique designs with such a "function Object() { [native code] }," which is unheard of in the traditional world.
Oracles are reliable data sources.
To gain a better understanding of DeFi, you must first grasp how different tokens work in the bitcoin ecosystem. Let's start with the fundamentals of oracles.
Oracle is a smart contract agent that discovers and confirms real occurrences before transferring the information to the blockchain. Oracles are needed in smart contracts to emphasise details that aren't always known or understood at the time of writing.
For example, Alice and Bob are betting on Saturday's temperature. Alice predicts a temperature of 20° C or higher, whereas Bob predicts a temperature of 19° C or lower. They create a smart contract in which both parties give the monies to the winner. The smart contract must request oracle as a dependable resource to define the temperature. The smart contract will consult the weather news website, which will serve as the oracle in this case.
what exactly is defiant?
toptal.com is the source for this information.
Oracles are employed in a variety of blockchain product development sectors that involve smart contracts. Oracles, on the other hand, are very popular and widely employed in DeFi initiatives. Furthermore, this link is so strong that many crypto analysts classify oracle tokens as DeFi tokens.
The following are some of the most notable uses of oracles in DeFi:
Real asset prices must be displayed on the web for synthetic asset platforms. Tokens linked to actual assets such as gold, indices, stocks, or cryptocurrency are created via oracles.
To guarantee the entire value of the collateral, lending and borrowing platforms require oracle participation. Loans are issued and repaid, collateral is repaid, and interest payments are calculated.
A price stream is required for stablecoins to certify the value of the underlying asset's collateral. Stablecoins that are tied to fiat currencies, currency baskets, or commodities are created using them.
The ChainLink blockchain can be called the indisputable leader among all oracles. It is a pioneer in the provision of accurate data for DeFi, and its LINK token, which has a market capitalization of $ 5.86 billion, is now listed as the number one oracle token. The token entirely rebounded after a price drop in March this year owing to the epidemic, and in July it reached a historical high. Since then, it has grown at an exponential rate. Prices have risen by 463 percent since the beginning of the year. Among the top coins, this is the highest growth.
Tokenization of Assets
Tokenization allows assets that were previously unable to enter the DeFi ecosystem to do so. Its asset-backed composability opens up new options.
Tokenization's main purpose is to increase asset holders' accessibility and make transactions more efficient. In a matter of seconds, tokenized assets can be transferred to anyone in the globe. They may be stored in smart contracts and used in a variety of decentralised apps. The DeFi ecosystem relies heavily on these tokens.
Tokenization refers to the act of adding new assets to the blockchain (public blockchains), and a token refers to the representation of an asset on the blockchain product development system. There are a variety of technology options for creating public Blockchain tokens. Most of these options, however, can be overlooked because most tokens are created on the Ethereum blockchain using the ERC-20 token standard, which is a smart contract template. These tokens are compatible with nearly all DeFi apps.
Tokenization's Advantages
The financial market is brimming with a wide range of assets. Tokenization of physical assets is transforming the way we manage them, allowing us to take advantage of hitherto unattainable benefits. Some of them are described in the following paragraphs.
Programmability. Tokenization, which is key to blockchain assets and utterly absent from traditional financial alternatives, provides programmable money. The capacity to programme valuable objects to shift from one person or organisation to another owner if and only if specific conditions are met has a lot of potential for generating valuable items while also lowering operational costs. A simple first example is a tokenized share that distributes a percentage of its net income as a quarterly dividend only to token holders who have a positive quarterly net profit. The tedious and time-consuming process of issuing quarterly dividends will be considerably reduced by pre-programming this dividend function. Tokens that be convertible between stock and debt securities based on established parameters are a more complicated example. Anyone may verify the protocol's correct execution thanks to the transparency of the public chain of blocks.
Investment in a fraction of a percent. For the common investor, fractional ownership will open up new asset classes and allow for smaller investment amounts. Purchases of art pieces, for example, are frequently made through a closed bidding procedure rather than a public market process, which results in exclusive ownership (one owner per asset) rather than shared ownership (many co-owners of one asset). Owning an auction market alone would be equivalent to owning one “Mona Lisa share” worth $800 million for something like the Mona Lisa. Ten million shares of Mona Lisa, valued at $80 each, might be held in market-share ownership. Because there are so many more people on the planet who can afford to spend $80 on a famous work of art, a liquid market of buyers and sellers will emerge, making trading faster and less expensive. Compare this to the time-consuming and costly illiquid method: today, you must find the single buyer willing and able to spend $800 million on a picture. This applies to real estate investments as well.
investment in defi at a tenth of the cost
Liquidity. Fractionation, as seen in the Mona Lisa example, can help buyers and sellers have more favourable liquidity, allowing them to complete deals without difficulty. To be clear, the tokenization procedure does not improve an asset's liquidity; but, the rise in the number of possible buyers and sellers that occurs as a result of tokenization's share ownership function contributes to this effect. Because illiquid asset investors bear the risk of not finding a buyer, they must entice the buyer with a lower price, dubbed the "discount for illiquid assets." This discount is applied to all illiquid assets and is considered to be 20-30% of the asset's genuine value. It is feasible to use the tokenization process to
Increase true value by optimising markets for previously illiquid asset groups.
Management of a Portfolio
The process of watching your assets and controlling their cash flow in order to earn returns on your investments is known as portfolio management. Active and passive portfolio management are the two basic types of portfolio management. Active portfolio management entails a group of portfolio managers making investment decisions in order to outperform a benchmark, such as the S&P 500. Passive portfolio management does not necessitate the use of a team; it entails as closely as possible replicating the return of a specific benchmark. Some DeFi projects already allow for decentralised passive portfolio management. Users may readily see how their assets are managed and understand the charges they will suffer because to DeFi's transparency.
Loans and Lending
Traditional financial systems demand users to have bank accounts in order to access their services, which about 2 billion individuals do not have. Other requirements for obtaining a bank loan include having a solid credit rating and sufficient collateral to persuade the bank that the applicant is deserving of the loan and capable of repaying it. By allowing anyone can utilise their digital assets as collateral to receive loans, decentralised lending and borrowing removes this obstacle. You may also use your digital assets to earn money in the lending market by donating them to loan pools and collecting interest on them. There is no need for a bank account or a credit check with decentralised lending and borrowing.
Insurance
In the event of an accident, insurance is a risk management technique in which a person receives financial protection or reimbursement from an insurance provider. Typically, people get insurance for their automobiles, houses, health, and life. Is there, however, decentralised DeFi insurance? All coins used in smart contracts are at risk of being targeted by hackers. Despite the fact that most projects' code has been inspected, there is no way of knowing whether their smart contracts are actually safe. A break-in is always a possibility, which can result in losses. These dangers necessitate the purchase of insurance, especially if you deal with big sums of money.
Exchanges
You can trade one cryptocurrency for another on exchanges like Coinbase or Binance. These centralised exchanges serve as both mediators and custodians for traded assets. Users of these exchanges do not have complete control over their assets, putting them at danger if the exchanges are hacked and fail to pay their debts. Users can swap cryptocurrencies without needing to transmit their coins to a custodian on decentralised exchanges, which solves this problem. Users don't have to trust centralised exchanges to stay stable if they don't put their funds there.
Derivatives
A derivative is a contract whose value is based on the value of another underlying asset, such as stocks, commodities, currencies, indexes, bonds, or interest rates. In any trade, traders can utilise derivatives to hedge their holdings and reduce risk. The majority of derivatives are traded on centralised platforms. Decentralized derivatives markets are being created by DeFi platforms.
Stablecoins
The value of cryptocurrencies is quite variable. Stablecoins were established and tied to several stable assets, including the US dollar, to reduce volatility. Stablecoins are supposed to operate as a reliable medium of exchange and assist users hedge against cryptocurrency volatility. Stablecoins have fast evolved into a robust DeFi component that is critical to this modular ecosystem's success. On CoinGecko, there are presently 33 stablecoins. The top five stablecoins have a combined market capitalization of more than $25 billion.
Stablecoins created by decentralised over-collateralization, operated in decentralised ledgers, and administered by decentralised autonomous organisations are designed to address this trust issue. Furthermore, anyone can verify their reserves openly. While stablecoins are not a financial application in and of itself, they are essential because they provide a stable store of value, which makes DeFi apps more accessible to all.
Stablecoins are not all created equal, as they use different strategies to keep their peg to the US dollar. Stablecoins are divided into two categories: those backed by local currencies and those backed by cryptocurrencies. To keep their peg to the US dollar, most stablecoins rely on a local currency backing system.
Important: Why is collateral required for protocols?
In order to lower the chances of something bad happening.
Do you want to receive stable currency Dai in exchange for fluctuating ETH, with the option of getting your ETH back at its original price when it matures, for example? To do so, you'll need to deposit ETH in a 1 to 1.7 ratio. That is, you must deposit $ 1.7 in ETH for every $1 in Dai. This is to assure the protocol's functionality and security.
In a similar way, several other loan methods operate. You must already be a member of the crypto economy and provide collateral to obtain a loan. In a decentralised environment, loans without collateral are impossible until the concept of distributed reputation and identity evolves. In other words, because credit grading anonymous wallets based on their past behaviour is impossible, all credit relationships will be based on the whole bank reserve model.
Who is in charge of the protocols?
It all relies on the protocol in question and its current stage of development. Developers typically retain a large amount of control over the protocol and its participants when it first launches. There is a red button on them.
Many protocols are transferred to user control as development progresses. Tokens that grant the right to vote are utilised for this. The MKR token, for example, grants the opportunity to vote on which assets might be used as collateral for the Dai stablecoin. The Synthetix derivatives platform is administered by three DAOs with voting rights for SNX holders.
Dai Vs Sai (SAI) is also known as Single-Collateral Dai because it is solely backed by Ether (ETH). With the debut of this mono-collateral Dai on December 19, 2017, Maker began its work. Maker announced the launch of a new multi-collateral Dai on November 18, 2019, to back up Ether (ETH), Basic Attention Token (BAT), and other cryptocurrencies. Maker will advocate multi-collateral Dai as the de facto stablecoin standard in the future, with Sai eventually being phased out and no longer maintained.
How does Maker ensure that users get the most out of their experience?
The black swan is a rare and surprising event that can have significant ramifications. Maker can trigger an Emergency Shutdown if the value of ETH and BAT drops dramatically. It's a last-ditch method of settling the Maker platform by closing all open positions in the system.
DeFi vs. Fintech: What's the Difference?
In reality, decentralised finance and financial technology are frequently misconstrued. Both systems operate through the Internet and provide financial services without the involvement of traditional financial institutions such as banks. However, there are a few key distinctions between the two markets. Fintech brings the existing financial system to the internet, whereas decentralised finance is based on the blockchain.
Square, a fintech behemoth, is a cross-border payment system that is speedier and less expensive than traditional banks. At the same time, the company's platform runs with the involvement of a central authority in the shape of Square. Customers must supply reliable identifying details before opening an account, and the site handles transactions on their behalf.
It appears to be different in the case of DeFi. Dai is a stablecoin based on Ethereum that is tethered to the US dollar. A user that transacts with this currency does not have to trust a specific entity to complete the transaction. Instead, miners on the Ethereum blockchain confirm the transaction.
Taking a Step Back From the Initial Coin Offering World Native tokens of a DeFi development company are becoming an important tool for incentivizing participants, and while only ordinary tokens were initially issued, the emergence of digital assets (governance tokens) has recently been observed, which can provide rights to participate in the site's work. Yearn.finance, UNI (Uniswap), and others are examples. The rise of governance tokens can be ascribed to the fact that, unlike the ICO boom, investors desire to have a direct influence on project implementation.
DeFi Development Company has formalised its transition from ICO projects. If an initial coin offering (ICO) is a storey about investors being obliged to trust people who coordinate the supply of certain tokens, DeFi is a technology mechanism based on smart contracts rather than human decisions. This could give investors more confidence in their investments.
Getting Rid of Traditional Finance Issues
DeFi is a movement focused at addressing traditional finance's key issues, such as transaction speed, regulatory oversight, excessive costs, and limited availability. It has the ability to bridge these gaps and offer everyone with unrestricted access to financial activities. Decentralized Finances have the following significant advantages, according to Cryptoauxiliary:
Transactions are fast and transparent thanks to decentralisation, which gives all players authority over the ecosystem at the same time.
There aren't any middlemen;
Smart contracts for management;
Code that is open source that may be examined and modified at any time, as well as utilised to create other services based on it;
Operational speed and cheap cost in decentralised networks;
The immutability of the blockchain-enabled contracts;
Transparency and auditability;
Lack of centralised management—everything is based on pre-programmed smart contracts;
No one can change the contract in their favour invisibly. and
Anyone with access to the Internet, regardless of nation of residence or other considerations, can participate in the DeFi market.
Hazards and Risks of DeFi
Despite its many benefits, decentralised finance also has its drawbacks. Given the technology's youth, this is understandable. The following are the primary dangers:
Smart contracts can be hacked. A person wrote the code, and it is human nature to make mistakes. It makes prudent to only use platforms that have been validated by reputable auditors, yet even then there's a chance you'll miss something critical.
Credit and liquidity risks The cryptocurrency is highly volatile, and if the underlying asset falls dramatically, the system may collapse. Over-collateralized loans are used in DeFi protocols to counteract this problem.
There aren't enough dollars to lend. When compared to a regular financial institution, DeFi allows you to acquire a smaller loan with specific collateral.
Oracles that aren't real. Data (cryptocurrency rates, for example) is received via blockchain protocols from external systems, which are frequently centralised. Smart contracts will be executed erroneously if the source is unreliable. Decentralized source alternatives are being developed to eliminate this risk.
Control of development from a central location. Regardless matter what anyone says, one team is working on the code. DeFi developers are increasingly involving consumers in the process, although this can lead to issues owing to inept intervention. Finding a responsible person is challenging. The decentralised governance notion does not always work out the way it was planned. Although all users are equal, there are others who want to destroy the ecosystem or who are just passive and will not participate in the process (which often does no less harm than the actions of intruders).
Nonetheless, DeFi is generating a lot of attention right now. The field appears to be incredibly promising, and many businesses have already used or are preparing to adopt DeFi solutions into their service offerings. In 2020, Cointelegraph conducted a survey, and the findings are astounding. Almost half of all existing platforms want to provide DeFi bespoke commercial services. So, if you've ever wanted to start a DeFi project, now is the best time to do so.
Final Thoughts
We simply touched on the most important components of decentralised finance because it is a vast subject. Hundreds of applications in this field have been developed and are currently operational. Compound and Uniswap, for example, have become quite popular in a couple of months. Large corporations have not overlooked DeFi's potential. The Binance exchange, for example, saw the need to establish Binance DEX, a decentralised platform.
Residents in nations with weak or unpredictable economies might benefit greatly from DeFi applications and projects. In Argentina, for example, due to the country's horrendous inflation, it was even suggested that people be paid in DAI. Services are in high demand in industrialised countries as well, as they provide a more profitable and inexpensive lending system as well as new options for investment interest income.
Financial services that are efficient and transparent are critical for including users in the ecosystem, and unlike the old financial system's failed attempts, decentralised finance is making progress toward the necessary paradigm change.
When DeFi is completely developed, libraries from outside the crypto community should be expected to be used. With just one line of code, you can create a completely decentralised marketplace in the video game. Add an extra line if you want to provide sellers on a business site a discount on balances.
Blockchain, according to many economic visionaries, is the core technology of the digital economy, on which an inclusive society based on mutual creation and trust will be established. Cryptoauxiliary is a forerunner in this field. Cryptoauxiliary is at your disposal if you want to start a DeFi project, audit smart contacts, or get help with your blockchain platform.