If you are reading this, you are more than likely familiar with cryptocurrencies. You have probably heard about DeFi and the talk that it is the future of finance. But what exactly is DeFi? Unless you’re a blockchain programmer or a crypto expert, you might still have a foggy concept.
To help you understand this, we have put together an explainer for you.
DeFi is short for decentralized finance.
DeFi is a form of finance that takes place on the blockchain and does not rely on brokerages, exchanges, or banks to offer traditional financial instruments. Instead of centralized financial intermediaries, DeFi platforms leverage smart contracts for transactions. This is currently being done with a wide range of lending, trading and betting activities.
A smart contract is a contract that executes by itself, without the need of a trusted third party. The terms of the agreement between two counterparties can be directly written into lines of computer code. The code and the agreements are frequently recorded on a blockchain, or distributed ledger.
But what makes a cryptocurrency protocol “DeFi”? DeFi generally has five characteristics:
Non-Custodial. Users are the only ones who hold the keys to their wallets and control their funds.
Open. It’s like the internet, but instead of information being transferred globally with no borders, the same is happening with money.
Transparent. The code for these financial applications is open, so anyone can inspect how the applications and protocols work, and track exactly where their money is.
Programmable. Open-source code also enables developers to build on top of others’ applications. And if they don’t like it, they can copy it and build a new application.
Decentralized. DeFi protocols are built on public blockchains like Ethereum.
DeFi was made possible by the creation of smart contracts. The first broad usage of this was on the Ethereum blockchain launched in 2015. The term was first used in 2018 to describe the movement of open financial applications being built on Ethereum blockchain.
Since then, DeFi projects have been built on other blockchains as well. Last summer, the market for DeFi projects, tokens and exchanges exploded, and this year, it has only grown in scope.
The market for DeFi is hot. It was worth $80 billion at the time of this writing, and had a daily trading volume of $8 billion, according to CoinMarketCap data. Most of these projects are on Ethereum and the Binance Smart Chain.
Here are some of the most popular projects in DeFi right now:
Uniswap
Uniswap is a popular decentralized trading protocol and exchange built on Ethereum, known for its role in facilitating automated trading of DeFi tokens. Launched in November 2018, it gained considerable popularity last year thanks to DeFi market growth and the associated surge in token trading. This protocol automates the trading of digital assets and makes it completely open to anyone who holds tokens, while providing more efficient trading than traditional exchanges.
The governance token UNI is part of the Uniswap protocol which is used to facilitate transactions on the exchange. This added both profitability potential and the ability for users to shape its future — an attractive aspect of decentralized entities.
Daily trading volume recently exceeded $1 billion on this exchange, additional CoinMarketCap figures reveal.
PancakeSwap
PancakeSwap is a decentralized exchange built on the Binance Smart Chain.
It launched in September 2020, and similar to Uniswap for Ethereum, it is for swapping BEP20 tokens on Binance Smart Chain. PancakeSwap uses an automated market maker model where users trade against a liquidity pool. These pools are filled by users who deposit their funds into the pool and receive liquidity provider (LP) tokens in return.
These deposited tokens later award them their share of the pool, as well as a portion of the trading fees. These LP tokens are known as FLIP. PancakeSwap also allows users to farm additional tokens such as CAKE and SYRUP. On the farm, users can deposit LP tokens and get rewarded with CAKE.
This decentralized exchange has been benefiting from notable trading volume, recently reaching $400 million in daily turnover.
SushiSwap
SushiSwap launched in September 2020 as a fork of Uniswap, and aims to improve on the decentralized exchange and ecosystem of the former. This protocol adds features not previously present on Uniswap, such as increased rewards for network participants via its in-house token, SUSHI.
At the time of this writing, the daily trading volume on the SushiSwap exchange surpassed $170 million.
Chainlink
Founded in 2017, Chainlink is a blockchain that allows for universally connected smart contracts. Through a decentralized oracle network, Chainlink allows blockchains to securely interact with external data feeds, events and payment methods, providing the critical off-chain information needed by complex smart contracts to become the dominant form of digital agreement.
When this article was written, the Link token had a market cap of $7 billion.
Aave
Aave is a decentralized finance protocol that allows people to lend and borrow crypto. It is also the name of its native token.
Lenders earn interest by depositing digital assets into specially created liquidity pools. Borrowers can then use their crypto as collateral to take out a flash loan using this liquidity.
Aave is the Finnish word for “ghost.” When the project first launched in November 2017, it was called ETHLend. Then, in September 2018, it underwent a rebranding, changing its name to Aave. AAVE provides holders with discounted fees on the platform.
At the time of this report, the Aave token had a market cap of $3.5 billion, and the total value locked (TVL) on the network was $6.9 billion.
Compound
Compound is a DeFi lending protocol that allows users to earn interest on their cryptocurrencies by depositing them into one of several pools supported by the platform.
When a user deposits tokens to a Compound pool, they receive cTokens in return. These cTokens represent the individual’s stake in the pool and can be used to redeem the underlying cryptocurrency initially deposited into the pool at any time.
For example, by depositing ETH into a pool, you will receive cETH in return. Over time, the exchange rate of these cTokens to the underlying asset increases, which means you can redeem them for more of the underlying asset than you initially put in — this is how the interest is distributed.
On the flip side, borrowers can take a secured loan from any Compound pool by depositing collateral. The maximum loan-to-value (LTV) ratio varies based on the collateral asset, but currently ranges from 50 to 75%. The interest rate paid varies by borrowed asset and borrowers can face automatic liquidation if their collateral falls below a specific maintenance threshold.
Compound’s native token had a market cap of $2.1 billion at the time this article was produced, and the network had $6.9 Billion in TVL.
Where are We Headed
While we don’t have a crystal ball, we take the definite position that we are still very early in this market. The DeFi market could explode in the next decade as society moves toward decentralized infrastructures.
This content is for educational purposes only. It does not constitute trading advice. Past performance does not indicate future results. Do not invest more than you can afford to lose. The author of this article may hold assets mentioned in the piece.
