Decentralized finance, or DeFi for short, has shaken the crypto-blockchain world. However, its latest revival is hiding its roots in the 2017 bubble era. While everyone was doing their dog’s Coin Initial Offer, or ICO, few companies saw the potential for blockchain, which was far greater than the rapid rise in prices. These pioneers envisioned a world where financial applications, from trading to savings, banking to insurance, could all be done simply in a blockchain without an intermediary.
To understand the potential of this revolution, imagine if you have a savings account with an annual yield of 10% in US dollars, but without the bank, practically without the risk of funds. Imagine being able to trade crop insurance with a Ghanaian farmer sitting in your Tokyo office. Imagine for a second you were transposed into the karmic driven world of Earl. Sounds too good to be true. That is not the case. This future is already here.
DeFi building materials
There are some basic building blocks of DeFi that you need to know before moving on.
Automated marketing or exchange of one asset with another without trust, without an intermediary or clearing house.
Over-secured lending or being able to “use your assets” for traders, speculators և long-term owners.
Stable coins or algorithmic assets that track the underlying price without being centralized or secured by physical assets.
Understanding how DeFi is created
Stablecoin is often used in DeFi because it mimics traditional fiat currencies such as the US dollar. This is a significant development because the history of crypto shows how volatile things are. Stable coins like the DAI are designed to trace the US dollar slightly backwards even in strong bear markets, that is, even if the crypto price is falling, as in the 2018-2020 bear market.
Lending protocols are an interesting development that is usually built on stablecoin. Imagine if you could borrow $ 1 million worth of assets and borrow them in stablecoin. The protocol will automatically sell your assets if you do not repay the loan when your collateral is no longer sufficient.
Automated marketers form the basis of the entire DeFi ecosystem. Without it, you are stuck in an inherited financial system where you have to trust your broker or clearing house or exchange. Automated market makers, or AMMs for short, allow you to exchange one asset for another based on a reserve of two assets in its pools. Price disclosure is done through external arbitrations. Liquidity is consolidated based on other people’s assets և they receive trade fees.
You can now access a wide range of assets in the Ethereum ecosystem without having to deal with the traditional financial world. You can make money by lending assets or being a market maker.
This is an amazing innovation for the developing world, as they now have access to the full suite of financial systems of the developed world without barriers to entry.