What is defi : crypto decentralized finance explained
Today we will focus on DeFi, or decentralized finance, which is beginning to become a very interesting, broad and complex ecosystem. We will see what lies behind the term”decentralized finance”,the important players in the sector and the innovations to come.
What is decentralized finance?
If we are talking about decentralized finance, do we include the entire cryptocurrency ecosystem? Not really, because if the latter allow the transmission of value without central control entities, they cannot really be defined as financial products. Moreover, let us not forget the term “decentralized” in the acronym DeFi, today quite few players in the ecosystem are decentralized. Indeed, most exchange platforms are traditional companies that provide efficient but centralized services.
Decentralized finance therefore represents an ecosystem where everyone could benefit from different services and financial products without control entities. This means that, for example, any user could access loans without discrimination. Today, access to technology is no longer the main barrier to accessing financial services. Furthermost everyone outside the banking system have access to the internet. This is one of Libra’s arguments. These are usually identity issues or political restrictions that prevent access to banks. Decentralized finance therefore wishes to provide its services to all, without any restrictions.
Today we are at the beginning of DeFi, and things are changing very quickly. Many projects are emerging, and existing projects are gaining momentum. More and more users and therefore more and more cash and volumes arrive on the various DeFi applications. The user experience, one of the main barriers to adoption by the general public, is being improved and decentralized finance is coming to our smartphones.
An ecosystem relies above all on the different actors that make it up. All the more so when we talk about decentralization, where synergy between these players can create more interesting services for users. Let’s take a look at this ecosystem together.
Decentralized platforms have notably appeared with Ethereum. Indeed, smart-contracts that allow to create tokens according to a very specific standard and widely used, simplifying their implementation. So these are exchange platforms similar to traditional ones, such as Coinbase or Kraken for example. But while these are centralized, you deposit your funds on the platform and hope you can get them back. Other platforms are decentralized, your cryptos do not leave your wallet. It is user-to-user exchanges that are set up. They use advanced features such as atomic swaps to enable token exchanges more quickly between users.
Unfortunately still maturing, decentralized exchanges do not offer trading volumes and interfaces as interesting as traditional exchanges. But DEX (decentralized exchanges) are evolving very rapidly and it is now “very simple” to use their services. Some of these decentralized platforms have the particularity of allowing the purchase and exchange of non-fungible tokens.
If for many the volatility of cryptocurrencies is an opportunity, it is not for many cases of use. Indeed, making a loan whose value varies with such intensity as can be seen in the markets does not seem to be a very good idea. That’s why a particular type of cryptocurrencies appeared, the stablecoins.. They are tokens whose value is as fixed as possible, and tending towards the price of a fiat currency. The most common scenario is indexing to the U.S. dollar. There are two main methods for stabilizing the price of these tokens:
- Insurance by fiat currencies
- Insurance by other cryptocurrencies
The first scenario is the most common, we find in this category Tether or the USDC for example. They are tokens whose stability is guaranteed by the broadcasters of the latter. Indeed, it is the funds of these companies that, in theory, allow the exchange of their tokens with a 1/1 ratio to the US dollar. Various audits are in place to verify that they have enough cash for the number of tokens in circulation. These audits are sometimes the subject of many controversies and it is difficult to determine whether the issuers actually have the funds advertised.
The second (main) type of stablecoin works differently. They are guaranteed directly by cryptocurrency funds, or rather over-guaranteed due to the volatility of cryptos. The best known is the stablecoin Dai, deployed by MakerDAO. Everyone is free to create new tokens by providing a guarantee equivalent to 150% of the creation of tokens.
Access to loans is not possible for everyone, even if a guarantee is put into play (mortgage…). In addition, lower interest payments make lenders reluctant to make their funds available. The various loan systems offered by the ecosystem are an attractive alternative for both borrowers and lenders. Indeed, operating on a P2P (without intermediary) basis, this allows users to lend their cryptocurrencies to derive some interest.
A decentralized lending system therefore brings many benefits. The immediacy of transactions allows the loan over very short durations, for example a few weeks. No salary check is required, anyone can borrow. People outside the banking system could therefore access their first loans in this way. Most loans made are made to be used on trading platforms using leverage or other brokers currently.
Predictions of decentralized markets are a somewhat obscure component of decentralized finance. If this kind of system is widely used in today’s finance, they are mainly internal, or completely centralized like Aladdin. The implementation of these systems is complex, despite the potential of this type of service. Different solutions are provided by the players in this sector, such as the implementation of guarantees in case predictions fail, and rewards if they do not.
Today the main players are Augur, which makes it possible to make predictions on many subjects, as well as Gnosis, oriented on crypto markets. Today, these players are still struggling to attract users. Prediction volumes are still quite low, but the next features should allow for more traction to their services.
The major players in the sector
Let’s take a quick look at the players in decentralized finance, and the projects they carry. Of course, I will not be able to present them all, and my selection does not mean that these are the most interesting projects. Different DeFi themes are covered in this list.
One of the main players in decentralized finance. Services are based mainly on the Ethereum platform. These include the initiators of the stablecoin Dai, whose stability is based on the guarantee of ethers (and other options to come). These loans guaranteed to the tune of 150% help stabilize the price of token despite increases and decreases in the cryptocurrency used as collateral.
MakerDAO operates in a decentralized way, the community is often consulted on its development. The right to vote is proportional to the number of Maker tokens that users have. This allows anyone interested in the project to participate. In practice it is more complicated. Since recently a vote was held to change the loan fees of the Dai, and not everything went as one could imagine. In fact, only one entity had about 95% of the voting power. In addition, most users with Maker do not vote and therefore leave an opening to whales (people who own large amounts of a single crypto), this reduces the interest of setting up votes.
The Binance exchange platform is no longer presented, which has managed to gain a place in this competitive market and to develop extremely rapidly in a few years. But it’s his little brother that we’re going to talk about, Decentralized Binance or BinanceDEX. It is a decentralized exchange platform based on binance’s blockchain. It is a lot controversial when it is the real decentralization of the system. Indeed, the system relies on a rather small number of nodes, although theoretically this is enough to speak of decentralization. The black spot of the project is above all its operation in relation to the tokens of the chain. If you want to exchange bitcoins on the platform, you will have to send your bitcoins to Binance which will trade them to you for “bitcoins.d”. So it’s too centralized to really talk about decentralization, you’re just exchanging a new type of tokens related to Binance.
Compound is a project to make loans on the Ethereum platform. It is decentralized and usable by any Ethereum user. Compound allows ether owners or certain Ethereum tokens to earn interest by lending them to other users. The exchange also allows other users to borrow these assets, without having to negotiate the terms with a trusted third party. Unlike many systems based on Ethereum, Compound has no related tokens. In fact, they charge a fee for each loan made through their system.
Silver is an Ethereum wallet available on smartphone. It has a very modern interface and user experience. If he is on that list, it is not only because of his qualities. Indeed, even if it has the goal of making the decentralized web more accessible, Silver does not only store and transfer its ethers and other Ethereum tokens. It also gives you direct access to decentralized finance services.
The team has integrated into the application services such as Compound or MakerDAO presented above in the article. If you store your ethers on the Silver wallet, you can very easily put them in collateral to get Dai or lend them to other users for interest. The use is very simple, just select the token you want to put on loan, quantity and that’s it. A real user experience lesson!
Monolith is, in their own words, a decentralized alternative to banking services. Their services are based on the Ethereum platform, and therefore interact with the different tokens of the ecosystem. Like most DeFi mobile apps, the user experience and interface have been neat. The wallet is not custodial, it means that you are in full possession of your ethers and other tokens. The features are similar to what can be found in FinTech, but for the Ethereum ecosystem. Monolith even offers a Visa bank card, which allows you to spend your cryptocurrencies at merchants. Note that the latter is only available to European residents and requires a KYC (identity verification).