Origin, what is DeFi and what are its’ use cases.
Throughout history, people have been trading goods in exchange for services. Together with the development of humankind, the importance of currency arose. We invented currencies to make exchanging and trading easier. Currencies at the same time require someone to control the use and production of it. Authorities such as central banks and different financial institutions (banks) were established with a goal of managing and regulating the supply of currencies that is available for circulation.
With growing importance of currencies, the power that authorities possess has also increased rapidly. Central banks can print money whenever they decide to do so. People have to trust them with their decisions. At the same time, most of the population uses different banks to store money or invest it. Banks are therefore gaining control of all that money in exchange for small interest rates. That is why DeFi is becoming a more and more popular topic.
What is DeFi?
DeFi is currently arising as one of the most popular topics in crypto. It is an abbreviation for decentralized finance. One referring to DeFi will usually think of digital assets and different financial smart contracts. Besides that, the phrase decentralized finance also stands for various protocols and decentralized applications, all mostly built on the Ethereum network. All in all, DeFi represents financial software, which is built on the blockchain. It is a system that offers different ways to develop and build financial tools and services, while being decentralized and with an ability to modify when needed.
DeFi at the moment represents decentralized finance, which can play the role of financial instruments, while all being decentralized and without any governing body. The goal of DeFi is to try and recreate the banking system, which could be used by society. It could enable people full control over their assets, while at the same time giving an option for upgrades and collaboration, with which new financial products could be made.
DeFi mainly became popular due to the fact that it offers you control over your assets. Its aim is to create a financial system that is available to everyone and anyone can use, while at the same time mostly excluding central authority out of it. Blockchain allows everyone to verify and check a transaction that occurs, therefore eliminating the need for 3rd parties.
Banks and different financial institutions are trying to give their users control; however, they are still the ones managing your funds. The main purpose of DeFi is to give users complete control of their assets, mostly due to blockchain technology and decentralization. Due to the fact that protocols are available to anyone (open-source), many developers are trying to build new apps and financial products with the goal of making better products that offer more security. The growing popularity of it also leads to innovation and faster development. Anyone using DeFi can store or invest their assets in blockchain securely, while at the same time, earning a higher return on their investment in comparison to the traditional financial systems that the majority still use. As previously mentioned, there is no need for a third party to handle the assets and you have your own control over the investment.
DeFi Products and application
There are various products available that involve DeFi. They all represent an open finance system using blockchain technology and several open protocols which are being integrated into financial structures. DeFi products vary from: Open Lending Protocols (MakerDAO), Issuance Platforms and Investing (Polymath), Decentralized Prediction Markets (Augur), Exchanges and Open Marketplaces (IDEX) and Stablecoins (Dai).
Dai is the first decentralized stable coin, launched by MakerDao. It is linked to US dollar, meaning that the price of one Dai should always equal around $1 USD. Dai uses the Ethereum network. At the same time, it is backed by Ethereum. That makes it decentralized and at the same time not relying on any banks or other control institutions such as governments or central banks. It is constantly adapting and reacting to market conditions. The whole process is being regulated by Dai’s governance coins MKR. It is being used to regulate its economics.
An “option” is a type of derivative contract that gives the owner the option (not the obligation) to buy or sell an asset at a specified price (the strike price) within a predetermined time (the expiry date) — OKEX
Bitcoin options work in the same way as traditional options. The buyer has a basic option where he pays a premium which gives him the right (not obligation) to buy or sell an agreed amount of Bitcoin pre-agreed date. With options, users can generate income, make speculative bets or hedge when the market is volatile. Volatility goes hand in hand with crypto and options are a way to preserve investor's money.
In recent years we have also seen a rise of exchanges offering binary options. With them, traders can speculate on yes and no scenario. This means that traders can bet on the rise or fall of Bitcoin.
Cryptocurrency futures are Derivative Products. This means they are a form of contact between two parties. They can either buy or sell a crypto asset on a predefined date with pre-established price.
Crypto futures are a way to trade the future price action for crypto assets. — Pirus
As we are gambling on the future price of an asset, a futures contract can be considered as a bet. Participants can either go long, therefore betting on a price advance, or go short if anticipating a drop. When the expiration date arrives, parties settle and contract closes in profit or in a loss.
Stable coins have really expanded in recent years. Tether (first stablecoin) is joined by multiple other stablecoins. They are blockchain-issues tokens that are designed to maintain a stable peg to an outside asset like USD, EUR or gold. With emergence of new stablecoins there are also new models for issuing them. We can categorize them in 3 categories:
Crypto-collateralized, Fiat-Collateralized and Non-Collateralized.
Crypto-collateralized stablecoins include Maker’s Dai, where the underlying asset (e.g., ETH) is over-collateralized against the loaned asset (Dai) based on the current collateralization ratio.
Fiat-collateralized stablecoins are by far the most popular and include regulatory-compliant and audited coins like Tether, USDC, and Gemini Dollars. The models for these stablecoins do not differ very much at all, and they rely on their users trusting them by providing transparent audits that their USD reserves can back the current circulating supply of the token to maintain the price peg.
Non-collateralized stablecoins are neither centralized nor over-collateralized with crypto assets, and instead, rely on contractions and expansions of the supply based on an algorithm to maintain a stable peg. Basis was the flagship example of such a stablecoin but stumbled and shut down following regulatory concerns with its model late last year. — Blockonomi
There are two types of exchanges in the crypto world: decentralized and centralized exchanges. The main difference between both types is trust. On centralized exchanges, you need to trust a third party with your cryptocurrency. The decentralized exchange offers the user more security as you are responsible for your coin/tokens. This concept is called Proof of Keys, which means that you only have your cryptocurrency when you have it’s key. When you send it to a third party wallet you can lose it, if an exchange is hacked. Centralized exchanges are more prone to hacks as they store people’s coins or tokens on their wallets. While centralized exchanges suffer from hacks, decentralized exchanges suffer from liquidity and volume. DEXs also use some highly innovative methods for swapping tokens such as atomic swaps and other non-custodial means for exchanging one asset for another with minimal settlement time or risk. The most popular DEX out there is IDEX, a decentralized exchange built on Ethereum.
Other types of open marketplaces emphasize the exchange of non-fungible tokens (NFTs), often referred to as crypto-collectibles. Platforms like OpenSea and Rarebits facilitate the exploration, discovery, and buying/selling of crypto assets that range from NFTs in games like Cryptokitties to virtual land parcels in the Ethereum-based game Decentraland. — Blockonomi
Recently we have seen a jump in popularity of decentralized exchanges that use swap functions. Major players on this field are: Bancor, Uniswap and KyberSwap.