Today we’re going to discuss together what decentralized finance is in its broadest sense and what are the possibilities that DeFi offers us.
DeFi, or decentralized finance, refers to a whole series of financial applications that can make citizens independent from banks, insurances and other institutions and also, to some extent, from states. At the root of DeFi applications is a feature of the Ethereum cryptocurrency: smart contracts. These allow a computer program to be associated with a given currency.
What exactly can be done with this ever-growing sector? Today, there are many, many services offered by multiple protocols and applications. Here is a non-exhaustive list of the most mature and widely used services in DeFi:
- Traditional financial transactions such as trading or sending/receiving funds;
- Decentralized exchanges (DEX), platforms where buyers and sellers are connected to exchange assets.
- Lending/borrowing services, allowing the lending and borrowing of assets in a decentralized manner and without any form of justification;
- Flash-loans, which allow users to borrow very large amounts of money with very little collateralization. This money is then used in a flash strategy involving many transactions (such as arbitrage), and then repaid to the protocol. And all this in a single block.
- Full wallets, similar to banks, with many integrated financial services and direct connections to several blockchains;
- “Stablecoins” or cryptocurrencies paired with stablecoins such as the dollar or the euro. They allow users to access all the services offered with non-volatile currencies;
- Yield farming, a complex and semi-automated activity that consists of finding strategies that combine several protocols in order to increase returns tenfold;
Yes, the DeFi ecosystem is quite new but there is already talk of DeFi 2.0, so innovation never stops in the crypto market! The new decentralized finance also called DeFi 2.0 is going to propose solutions to stabilize finance within blockchains for good.
Some protocols are revolutionizing decentralized finance (which is already a revolution in itself). The pace is now very fast, a protocol can be born and die the same day if it is not approved by the community. Previously, someone who provided liquidity in a protocol received LP tokens (Liquidity Providing Token).
When they came back to get their liquidity, they would give the protocol the LP tokens back and leave with their liquidity. Now, liquidity providers become guarantors and have an incentive to permanently lock liquidity to the protocol. They then sell the LP token and receive a discount on the protocol’s governance token in exchange. In sum, the protocol no longer fears withdrawals from suppliers and thus low liquidity supply of its cash, since it now owns the cash.
Innovation in this sector is exponential and even if DeFi 2.0 is still in its infancy, I think we can expect great things.