DeFi and its applications
The world has witnessed a spectacular growth in cryptocurrencies over the last 12 years. The multi-million-dollar crypto industry is testament to this and major players like Bitcoin and Ethereum are household names now. However, financial services have generally been slow to adopt digital assets – mostly due to its price volatility, lack of clarity around safe crypto storage and uncertainty around regulations. These characteristics are undesirable for investing in financial assets and hence, there FIs have taken a cautious approach while leveraging the power of cryptos. In this regard, decentralized finance (DeFi) is poised to radically change the way in which the worlds of cryptos and financial services interact. Let’s take a deep dive into this upcoming phenomenon.
What is DeFi?
DeFi is an umbrella term for a variety of applications and projects in the public blockchain space geared toward disrupting the traditional finance world. Inspired by blockchain technology, DeFi is referred to as financial applications built on blockchain technologies, typically using smart contracts. Smart contracts are automated enforceable agreements that do not need intermediaries to execute and can be accessed by anyone with an internet connection.
DeFi consists of applications and peer-to-peer protocols developed on decentralized blockchain networks that require no access rights for easy lending, borrowing, or trading of financial tools. Most DeFi applications today are built using the Ethereum network, but many alternative public networks are emerging that deliver superior speed, scalability, security, and lower costs.
Applications – DeFi lending and borrowing
DeFi gave finance a new direction by enabling lending and borrowing. Widely regarded as ‘Open Finance’, decentralized lending offered crypto holders lending opportunities to gain annual yields. Decentralized borrowing allowed individuals to borrow money at a specific interest rate. The aim of lending and borrowing is to serve financial service use cases while fulfilling the needs of the cryptocurrency community.
Example: Launched in 2018, Compound Finance is a lending protocol developed on the Ethereum blockchain that allows users to gain interest by lending out assets or to borrow against collateral. The Compound protocol makes this possible by creating liquidity for cryptocurrencies through interest rates set using computer algorithms.
Applications – DeFi Decentralized exchanges
Decentralized Exchanges (DEx) are one of the essential functions of DeFi, with the maximum amount of capital locked compared to other DeFi protocols. DExs allow users to exchange or swap tokens with other assets, without a centralized intermediary or custodian. Traditional exchanges (centralized exchanges) offer similar options, but the investments offered are subject to that exchange’s will and costs. The extra cost on each transaction is another negative aspect of CExs, which DExs address.
Example: UniSwap is the largest automated token exchange by trading volume deployed on the Ethereum blockchain. UniSwap automated transactions between cryptocurrencies through smart contracts. UniSwap today offers three functionalities: swapping tokens, adding liquidity and removing liquidity.
Future of DeFi
We’re observing a quantum leap in the new possibilities of the functionalities of money through the innovation of distributed ledger technologies. Everyone can take part in the governance of DeFi protocols and get a seat at the table where the world of decentralized finance is actively created. The DeFi space is gradually catching up with the traditional financial system and despite some of the obstacles which are certain while operating on the edge of innovation, the world of decentralized finance is on the road to prosperity. At the point where DeFi and fintech map and merge, we’ll have an inflection point where nascent financial technology is just part of a new financial system. One that realizes the dream of being fast, secure, available and catering to our every financial need!