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Beginner’s guide to decentralized finance

Decentralized finance or DeFi can be a confusing term for the uninitiated. Recognized as a savior of legacy financial systems, DeFi implements a trailblazing concept of decentralization. This notion is so in vogue that the current DeFi market has seen a YoY 47% increase. In February 2022, it surpassed the level of $106 billion.

So what is crypto DeFi? And why should you care? Let’s find out.

Fundamentals of decentralized finance

The phenomenon of DeFi refers to the miscellany of decentralized financial instruments premised on the blockchain. These can be services or applications that offer users finance-related tools. The main purpose is to provide financial services using cryptocurrency, without any intermediary or third party.

Blockchain-based smart contracts (e.g Ethereum) are used to verify and facilitate secure financial transactions instead of institutions. DeFi allows people to lend and borrow, trade cryptocurrency, and earn interest income on savings accounts. 

Main benefits of DeFi

The unique value of decentralized finance is commonly associated with its blockchain nature. Thus, decentralization lays the ground for other advantages DeFi applications have.

Transparency

Over 90 percent of all DeFi traffic comes from the Ethereum blockchain. Ethereum, in turn, is a decentralized platform that keeps all transactions visible to other network users. It means that all processes go through verification by other network users, thus offering open network activity for all participants. Therefore, decentralized finance eliminates the in-built blind spots of traditional banking systems.

From a practical perspective, it facilitates and speeds up the supply chain. Thus, when suppliers can see when a company sends restock payments, they start preparing a shipment, thus minimizing delays.

Faster transactions

At the very beginning, blockchain transactions were slow due to the immaturity of the system. Today, DeFi transactions are run in real-time with no external verification. However, Bitcoin remains the slowest among the tokens with approximately 40 minutes worth of transaction processing time. On the contrary, TechPay Coin’s Blockchain boasts 15 seconds time-to-finality, which makes it the fastest blockchain.

Data immutability

The blockchain architecture also accounts for tamper-proof, secure, and auditable data. Since every node is connected to a chain of nodes, malicious agents have to alter each cryptographic hash to change the data. It means that no harmful record is possible inside the mainnet.

System accessibility

Unlike traditional financial services with a meticulous validation procedure, DeFi is inclusive. Anyone with a crypto wallet and an internet connection can run DeFi transactions. It means that blockchain can cover unbanked households. 

Main DeFi applications in 2022

The ecosystem of decentralized finance is burgeoning with new services and applications. According to Defi Pulse, the total value locked in DeFi stands at $76.99 billion and has had a resilient tendency from January to April 2022. Now let’s have a look at the most popular DeFi applications.

dApps

Decentralized applications are an essential component of the DeFi ecosystem. This software provides an intuitive and seamless interface for users to access DeFi services. The backend of these applications relies on smart contracts, while the front end is no different from traditional apps. Dapps provide functions with no human intervention and do not belong to a single entity. DeFi users can exchange, trade, or borrow tokens through dApps.

DEX

Just like a currency exchange point in a bank, decentralized exchanges enable users to trade cryptocurrencies with one another with no brokers. To enable automated exchanges, DEXs employ algorithms, instead of using traditional approaches of a financial intermediary.

As for the algorithms, these are smart contracts that trigger various outputs when given certain inputs. UniSwap and PancakeSwap are among the most popular decentralized exchanges.

Stablecoins

This cryptocurrency is collateralized by the value of the underlying asset. Typically, stable coins are based on the crypto/fiat combination, thus relying on dollars or euros. Compared with other cryptocurrencies, stablecoins are more stable. Tether is a prominent example of popular stablecoins.

Lending platforms

A crypto loan allows traders to access liquid dollars without having to sell their coins. Instead, they send their cryptocurrencies as collateral for cash or stablecoin loans. Users may choose to take out a crypto loan rather than sell it if they believe the value of their crypto-asset to rise or if they wish to hold the asset long enough to avoid short-term capital gains crypto tax rates.

DeFi loans are non-custodial thanks to smart contracts. Also, DEX platforms cannot lend fiat currency. Instead, they provide stablecoins to be exchanged for cash. Aave, MakerDAO, and Compound are the hall of fame among decentralized exchanges.

Prediction markets

Betting markets also fall into the DeFi realm and constitute a large part of the applications. The same as traditional decision markets, DeFi betting allows users to predict the outcome of future events and cash on the prediction. Just like the other applications, DeFi prediction markets do not have any intermediaries. Another differentiator of this use case is that DeFi betting markets are open to all users, regardless of status, location, or nationality, unlike traditional services of this kind.

Top DeFi applications in 2022

To further illustrate the possibilities of decentralization, let’s go over the most popular DeFi applications. Some of them enjoy stable popularity, while others have made an appearance just recently.

Compound

Compound is one of the most well-known credit protocols in the industry. It leans on smart contracts responsible for storing, managing, and distributing total capital. While a native COMP token yields no economic benefits, it allows you to vote for a wide range of platform changes. 

SushiSwap

Being the next version of the Uniswap exchange, SushiSwap inherited its liquidity and got an additional boost. The key difference is the endless remuneration of liquidity providers, even after they have withdrawn money. 

Polkadot

This application is a platform for cross-chain transactions, thus enabling the transfer of any assets between different blockchains. It opens wide opportunities for savings management and doesn’t limit it to the Ethereum blockchain.

Aave

This lending protocol allows users to deposit and borrow a wide range of cryptocurrencies using both more stable and variable interest rates. It also offers a collateral-free flash loan option. The latter includes instant rate switching for an existing deposit/loan and other unique features.

The bottom line

The crypto craze has acquired a new meaning in 2022. With advancing blockchain technologies and worldwide acceptance, decentralized finance is on the rise. DeFi applications offer a wealth of unmatched benefits such as increased accessibility and security. From decentralized exchanges to stablecoins, we will see more DeFi applications taking a genesis. Therefore, the full potential of this phenomenon is yet to be discovered.