The Full Guide to Decentralized Finance (DeFi)

Decentralized Finance (DeFi) Guide

This guide covers the most important categories of the DeFi sphere that promises to change the financial world as we know it.

CONTENTS

  1. Introduction to DeFi
  2. Stablecoins
  3. Payment Services
  4. Decentralized Borrowing and Lending
  5. Staking
  6. Decentralized Insurance
  7. Decentralized Exchanges (DEXes)
  8. Decentralized Identity
  9. Top DeFi Blockchain platforms

 

What is Decentralized Finance (DeFi)?

DeFi stands for Decentralized Finance and refers to a financial ecosystem that is built on top of blockchain technology. Most DeFi applications are built on top of Ethereum, but other protocols are used as well.

Vision:

DeFi aims to create a permissionless and transparent financial environment that is open-source and available to everyone without centralized control. DeFi includes a wide variety of financial applications such as payments, lending and borrowing money, insurance, and trading via decentralized exchanges. These applications are available to everyone through the use of decentralized blockchain networks and smart contracts.

DeFi Basic Principles:

  • Built on top of Blockchain Networks (mostly Ethereum)

  • Lacking centralized control

  • Open-sourced and available to everyone

  • Taking advantage of smart-contracts

  • Using blockchain automation to replace middlemen (reducing costs)

  • Taking advantage of blockchain composability (the composition of different protocols to build new services)

Composability:

An interesting feature of DeFi apps is the ability to compose different protocols to create new services. On the backend, DeFi protocols operate as a software library, allowing different smart contracts to plug into each other creating new applications. At this point, we must mention the project Chainlink (LINK). Chainlink uses a system of oracles to supply data to blockchains in a decentralized way that adds security and reliability to the whole process. This may prove particularly useful for the composition of DeFi apps by reducing security vulnerabilities and avoiding fraud.

DeFi Apps -On the backend, DeFi protocols operate as a software library, allowing different smart contracts to plug into each other creating new financial services...
DeFi Apps -On the backend, DeFi protocols operate as a software library, allowing different smart contracts to plug into each other creating new financial services...

 

Components of the DeFi Universe

Decentralized finance involves several categories of financial services.

 

Stablecoins (contents)

Stablecoins are digital currencies based on blockchain technology. However, unlike BTC or ETH, a stablecoin is pegged to a fiat currency, most commonly to the US dollar. Pegged with a fiat currency means it is practically stable at exactly 1.00 units of fiat.

Stablecoins are divided into four major categories:

(i) Fiat-collateralized stablecoins, backed by the equivalent fiat currency reserves (as mentioned above)

  • Key projects: True USD (TUSD), Tether (USDT), USD Coin (USDC)

(ii) Crypto-collateralized stablecoins, backed by cryptocurrency reserves

  • Key project: Multi-Collateral DAI (backed by collateral that includes Ethereum and ERC-20 tokens)

(iii) Commodity-collateralized stablecoins, backed by gold or gold-based financial products

  • Key project: Paxos Gold, HelloGold, Tether Gold

(iv) Non-collateralized stablecoins, backed by no reserves, relying on smart contracts and algorithms to maintain price equilibrium

  • Key project: Terra.money

 

Payment Services (contents)

DeFi payment services aim to create an open ecosystem that has no need for centralized control. Decentralized payment services are very promising for the underbanked and unbanked populations all over the world. According to the Global Findex Database 2017 (World Bank), there are about 1.7 billion adults that remain fully unbanked in the world (2 billion in 2014)

General Projects:

  • Lightning Network -This is a popular Layer-2 Bitcoin protocol that aims to facilitate micro-transactions and improve the scalability of the Bitcoin’s network

  • BitPay -Facilitates crypto payments via websites, email, etc.

  • Crypto.com ­-Accepting cryptocurrency payments on any website

 

Decentralized Borrowing & Lending (contents)

In the new DeFi world, anyone can lend or borrow money without the need of a bank account. Digital assets are used as collaterals for borrowing money, providing insurance in case of default. MakerDAO and Compound are the most important projects in this category (check below for full information). DeFi offers important advantages to lenders and borrowers over traditional banking, such as:

-Instant transactions, no documentation

-No bureaucracy, no need for approvals

-Full transparency and equal terms for all participants

-Available to anyone, without the need for a credit score

-Lower costs for borrowers and lenders, as there are no middlemen

-Collateralization of digital assets, no need for physical collaterals

Key Projects:

  • DAI is backed by collateral which is locked into audited and publicly available smart contracts. The project works with digital assets such as DAI, ETH, and MakerDAO. The interest rate is variable. The collateral requirement is 150% and the liquidation Penalty is 13%

  • Compound is built on Ethereum and uses a process of algorithmically determining interest rates for pools of tokens (called money markets) based on the supply and demand for each token. The project works with digital assets such as DAI, ETH, ZRX, REP, and BAT. The interest rates are variable. The Collateral Requirement is 150% and the liquidation penalty is 5%.

  • Atomic Loans Cross-chain collateralized loans, the protocol allows people to lock their Bitcoin as collateral and borrow Ethereum-based USD stablecoins

 

Staking (contents)

Staking is the same as earning interest through a savings account in a commercial bank. However, staking involves a different process. The validators of a crypto project stake a part of their holdings that gives them the right to validate and vote on blocks in the crypto network. In exchange, these validators are rewarded (like receiving interest).

Projects:

  • StakeWithUs -Staking-as-a-Service for PoS protocols

  • Figment networks -Stake tokens and build applications

  • Dokia Capital -An institutional staking service

 

Decentralized Insurance Services (contents)

DeFi creates new opportunities in the insurance industry. For example, the introduction of Peer-to-Peer insurance. P2P insurance works as a risk-sharing network where a group of people joins together to insure against a common risk, without an insurance company. Insurance on the blockchain offers significant advantages to customers:

-Fast transactions by eliminating bureaucracy

-Automatic-payments via event-based smart contract

-No need for intermediaries (lowering costs)

-Distribution of risk between all participants (minimal insurance premiums)

-Full transparency and equal terms for all participants

-Creation of completely new insurance services (parametric insurance, microinsurance)

Projects:

  • Etherisc -A decentralized insurance protocol to collectively build risk-transfer solutions

  • VouchForMe -Includes car insurance and income protection

  • Nexus Mutual -Covering hacking events on the blockchain (i.e. the DAO hack)

  • Opyn -Protect your DeFi deposits and hedge ETH risk

 

Decentralized Exchanges (DEXes) (contents)

A Decentralized Exchange (DEX) provides the ability to trade digital assets without the need for a trading account or a middleman. Every trade is made directly between user wallets, taking advantage of smart-contracts. A smart contract enables the automatic matching of the bid and ask orders (buyers/sellers). There are a lot of advantages for those traders using a DEX:

-No middlemen (lower fees than traditional centralized exchanges)

-Minimization of trading spreads

-Allowing true anonymity of transactions

-Allowing the issuance of an unlimited number of digital assets (synthetic digital assets, etc.)

-Allowing customizable parameters in the trading process

-The industry’s vision for the future is to create a fully peer-to-peer exchange of digital assets

Key Projects:

  • Augur –A peer-to-peer protocol that lets anyone create a market around the outcome of any real-world event

  • Ox -An open protocol that enables the peer-to-peer exchange of assets on the Ethereum blockchain. ZRX is the governance token that allows voting on protocol upgrades, and earn liquidity rewards

  • DEX AG -A trading interface that compares and tracks the best price from 11 different DEXes

  • dYdX -A non-custodial trading platform on Ethereum

  • Gnosis Protocol -Allows anyone to add any trading token pair

  • Kyber -Aggregates liquidity from a wide range of reserves, powering instant and secure token exchanges in any DeFi application

  • Synthetix - A decentralized platform on Ethereum for the creation of Synths (digital assets that track the value of real-world assets)

  • Uniswap - An on-chain protocol on Ethereum that uses liquidity pools instead of order books

 

Decentralized identity (contents)

According to the World Bank, all over the world, there are more than 1 billion people without an ID. In poor countries, 1 out of 2 women do not have an ID, limiting access to basic economic and political activities. Nevertheless, many of these people have access to a cheap smartphone. Therefore, a decentralized identity can play a major social role in these undeveloped countries.

Decentralized Identity and Credit Scores

As concerns DeFi lending, one key obstacle is the need for over-collateralization. As there are no credit scores, the lending protocols require collaterals up to 150% of the value of the loan. The decentralized identity and a reputation system will be able to ensure the reliability of each borrower. The decentralized identity will allow credit scores and consequently, reduce the collateralization requirements.

Key Projects:

  • Selfkey.org

  • Identity.com

  • Civic.com

  • Bloom.com

 

Top DeFi Blockchain platforms (contents)

The DeFi universe needs a blockchain framework to operate. Ethereum is the platform of choice for the vast majority of DeFi developers. Particularly important for DeFi will be the Ethereum upgrade to v.2.0. The upgrade will maintain data history and records of the initial Etherum v.1.0 chain, while it will offer scalability, more capacity, 1,000 transactions per second, and enhanced security.

(1) Ethereum

Ethereum is the first blockchain that introduced dApps and smart contracts. Today, more than 190 DeFi projects are built on top of the Ethereum network.

(2) EOS

EOS is the major Ethereum-competitor that managed to raise $4.1 billion in 2018 thought an Initial Coin Offering (ICO). Today, EOS is hosting more than 20 DeFi apps on its blockchain.

(3) Bitcoin

Bitcoin is the first blockchain network in the world and the epitome of a fully-decentralized ecosystem. Bitcoin is not as programmable as ETH and EOS, however, the Bitcoin blockchain is part of the DeFi universe in many ways. For example, BTC is used as collateral for borrowing money or via 2nd-layer payment solutions such as the Lightning Network. In total, about 24 DeFi apps are built on top of Bitcoin.

(4) Other Blockchains

There are other blockchains that are used in the DeFi world (i.e. Oikos on Tron), but they are not as important as the three blockchains mentioned before.

 

Decentralized Finance (DeFi) Guide

G. Protonotarios for ExpertSignal.com (c)

 

Sources:

https://defiprime.com/

  • Global Findex 2017 Report:

https://globalfindex.worldbank.org/sites/globalfindex/files/chapters/2017%20Findex%20full%20report_chapter2.pdf

  • The Block (image)

https://www.theblockcrypto.com/genesis/15376/mapping-out-ethereums-defi

  • Maker DAO & DAI

https://medium.com/alethio/the-defi-series-an-overview-of-the-ecosystem-and-major-protocols-da27d7b11191

  • DeFi Pulse (Links)

https://defipulse.com/defi-list/