Since the launch of Bitcoin in 2009, the concept of decentralized finance or DeFi has slowly come into existence. As of 2022, the global DeFi crypto market capitalization is close to $48 billion. If you are new to the world of crypto, you may not be familiar with the concept of decentralized finance. In this article, we quickly explain the concept of DeFi to you and also tell you about some of the most popular DeFi protocols that you can invest in today.
First things first: what is DeFi?
DeFi is a global and open financial system designed to keep up with the digital age. It is a new financial technology based on secure distributed ledgers, similar to those used by cryptocurrencies. DeFi mainly consists of financial services and products provided on public blockchains, primarily Ethereum. It is a viable alternative to an opaque and tightly controlled system maintained by decades-old infrastructure and processes.
Right now, the DeFi apps we have, like decentralized lending/borrowing and insurance, are essentially virtual representations of the same fiat apps, with the added benefit of being decentralized and giving users more control. from their own funds.
DeFi expands on the core principle of Bitcoin, creating a complete digital alternative to Wall Street without any of the associated costs (think office towers, trading floors, banker salaries). Markets are always open with DeFi. Moreover, there are no centralized authorities to block payments. You will not be denied access to anything. Services that were once slow and vulnerable to human error are now automatic and more secure, with code that anyone can inspect and scrutinize.
How does DeFi work?
Decentralized finance uses the same blockchain technology as cryptocurrencies. You can earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and do a variety of other things with DeFi. In the traditional financial system, intermediaries such as banks or stock exchanges are required to send or receive money. DeFi protocols replace these intermediaries. People trade directly with each other instead of going through banks and exchanges, with blockchain-based smart contracts doing the work of creating markets, settling trades, and ensuring the whole process is fair and worth of trust.
DeFi eliminates the high fees charged by banks and other financial institutions for using their services. Instead, individuals keep their money in a secure digital wallet, can transfer funds in minutes, and can use DeFi from anywhere with just an internet connection and a smartphone. For example, P2P (peer-to-peer) systems can meet an individual’s lending needs in DeFi – an algorithm will match borrowers with lenders, and a loan will be issued. Notably, P2P payments in DeFi are made through a decentralized application or DApp.
Popular DeFi Protocols
Now that we know what decentralized finance is, let’s take a look at some of the most popular DeFi protocols available to us today.
MakerDAO has become one of the flagship projects of the DeFi movement. MakerDAO is a peer-to-peer organization built on the Ethereum network that allows people to lend and borrow cryptocurrencies. Decentralized Autonomous Organization is another name for a peer-to-peer organization (DAO). He developed a protocol that allows anyone with ETH and a MetaMask wallet to lend money in the form of a stablecoin called DAI. The Maker Protocol uses Ethereum smart contracts to automate DAI collateral and lending, among other things.
For example, when the collateral value of a specific loan falls significantly below the loan amount in DAI, the loan is liquidated. As a result, the platform can sell collateral to repay DAI loans along with fees and penalties. You can see how liquidity and the threat of liquidation provide stability in blockchain lending and borrowing. MakerDAO essentially adapted the central bank model to blockchain and delegated governance to a network of token holders (MKR holders).
Aave is an open-source DeFi protocol for lending and borrowing cryptocurrency. Aave is a notable example of a DeFi solution designed to help users lend, borrow, and earn interest on crypto assets without the need for intermediaries.
Aave allows users to create loan pools. Borrowers at Aave must deposit crypto tokens as collateral to borrow, and users are only allowed to borrow up to the value of their collateral. A DAO, or Decentralized Autonomous Organization, is used by the protocol. Simply put, Aave is managed and governed by the people who own AAVE tokens and vote with them.
The AAVE cryptocurrency offers several advantages to holders. Borrowers who use the AAVE as collateral also benefit from reduced loan fees. Some loans, known as “flash loans”, can be issued and settled instantly through Aave. These loans do not require any initial collateral and are processed quickly.
One of the main platforms in today’s DeFi ecosystem, the decentralized crypto exchange, or DEX, is exemplified by Uniswap. After its launch in November 2018, it was one of the first decentralized finance (or DeFi) applications to gain traction on Ethereum. DEXs seek to address many of the issues that plague their centralized counterparts, such as hack risk, mismanagement, and arbitrary fees. It is, to be more precise, an automated liquidity protocol. Users do not need an order book or a centralized part for trading. Uniswap allows users to trade without the need for intermediaries, resulting in a high degree of decentralization and censorship resistance.
Moreover, Uniswap is completely open source. This means that anyone can copy the platform’s underlying code and use it to create their own decentralized exchanges.
To sum up, the many benefits of decentralized finance include anonymity, privacy, and better control over your own assets. And over time, DeFi’s many use cases will only grow in number.
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Disclaimer: Cryptos are unregulated virtual assets, not legal tender and subject to market risk. The views and opinions expressed in the article are those of the authors and do not represent investment advice or the official position of WazirX.
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