Decentralized Finance, or “DeFi” for short, has taken over the world of cryptography and blockchain. However, its latest revival hides its roots in the 2017 bubble season. While everyone and their dogs were making an “Initial Coin Offer,” or ICO, few companies saw the potential of the blockchain beyond a quick price gain. These pioneers envisioned a world where financial applications from trade savings to banking to insurance would all be possible without a middleman in the blockchain.
To understand the potential of this revolution, imagine if you were able to access a savings account that provides 10% of USD 10 per year, but without a bank and with almost no risky funds. Imagine that you can exchange crop insurance with a Ghanaian farmer sitting in your office in Tokyo. Imagine being a marketer and earning quotas as a percentage of what each Citadel would want. Does it sound good to be true? It is not. This future is already here.
DeFi building blocks
Here are some basic DeFi building blocks you need to know before moving on:
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Doing automated marketing or exchanging one asset with another without reliance on intermediaries or compensation.
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Excessive collateral or being able to “use your assets” by traders, speculators and long-term holders.
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Stablecoins or algorithmic assets without the centralized or protected physical assets that follow the price of an underlying one.
Understand how DeFi works
Stablecoins are often used in DeFi because they mimic traditional fiat currencies like the USD. This is an important development because the history of crypto shows how volatile things are. Stable currencies like DAI are designed to track the value of the USD with small deviations, even in strong markets, which means that the price of the crypto will fall like the 2018-2020 bear market.
Lending protocols are usually an interesting development built on stable coins. Imagine if you were able to block your assets worth a million dollars and then borrow them in stable currencies. The protocol will automatically sell your assets if you do not repay the loan when your collateral is insufficient.
Automated market makers form the basis of the entire DeFi ecosystem. Without it, you’re stuck with your brokerage or clearing house or the equity financial system you need to trust in an exchange. Automated marketers or, in short, AMMs allow you to trade one asset with another based on a reserve of two assets in its set. Price discovery occurs through external arbitrage. Liquidity is based on the assets of others and they have access to trading commissions.
You can now get exposure to many of the assets in the Ethereum ecosystem without having to interact with the traditional financial world. You can earn money by lending assets or being a market maker.
For the developing world, it is an amazing innovation, as they now have access to the entire set of developed world financial systems without barriers to access.