- What are tokens and why are they needed?
- How smart contracts work
- Services offered by DeFi
- Decentralized exchanges
- DeFi risks
- Перспективы DeFi
Decentralized finance (DeFi) is a term that includes the recently emerged financial system built on smart contracts in blockchain. The first breakthrough in this area was made by the developers of Etherium – they came up with a scheme to implement a software code that dictates the rules of the transaction. It is called a smart contract. The second aspect of the emergence of decentralized finance is token creation protocols, also invented in Etherium.
Cryptocurrency is the result of a blockchain; accordingly, each cryptocurrency exists in its own blockchain. While in real life we can go to a bank’s exchange office and exchange banknotes of one fiat currency for another, in the blockchain it is more difficult to do so. Tokens act as intermediaries, balancing crypto-assets with each other.
A token is issued by the DeFi platform and has a value. It can be purchased by paying with any cryptocurrency and will then act as collateral. In fact, a token is a blockchain entry that is made during a smart contract. This record contains data about the account and the number of tokens in it.
Tokens are used to conduct financial transactions in decentralized applications. They are not tied to a blockchain, but to a decentralized finance platform that provides financial services. Many tokens are successfully traded on exchanges and have their own value. In fact, a token is a conventional unit of measure within a decentralized finance service.
A smart contract is a software code that records the terms of a blockchain transaction. When you want to borrow cryptocurrency, issue an NFT, or lock your funds for interest, you make a transaction according to the rules written in the corresponding smart contract.
The upside of this approach is that there are no intermediaries, which reduces the time spent on financial transactions, saves money and almost eliminates human error. Commissions exist, but they are paid in gas – a small amount that is withdrawn from your account and sent either to the miner (in a PoW-based blockchain) or to participants in the network who have locked their assets into it (for PoS-based blockchains). In Etherium, this can be a tangible amount, but it is constantly changing and depends on the load on the network. So, at night on weekdays you can save a lot on commissions.
The smart contract has just one disadvantage – a possible software developer error. However, it is quickly detected and corrected. On the other hand, to remove the human factor in the bank is not easy – different employees can make the same mistakes all the time.
The field of decentralized finance is currently experiencing a rapid growth. So far, nothing fundamentally different from traditional finance has been invented in it, only solutions that are much more technologically advanced and profitable for consumers.
The decentralized finance market offers four key financial instruments.
This is similar to a deposit, but the interest is generally higher. In addition, staking is a separate technology that enables blockchain. Participants lock assets into the blockchain and these earn interest based on their share of the deposit. The purpose of locking the assets is to become nodes in the network, confirming transactions. Interest is accrued on each transaction.
This is in essence conventional lending, but more comparable to lending valuable assets to a pawn shop. Any funds can be lent, but it is necessary to lock a cryptocurrency for a larger amount than borrowed. This is done to protect the liquidity pool. If the cryptocurrency falls in value, the loan is canceled and the collateral funds are not returned.
Supply of liquidity
Funds for loans are taken from the liquidity pool, where users block cryptocurrency. These are referred to as liquidity providers. Stakes are subject to interest. You can usually withdraw your funds at any time. This type of earning is known as yield farming.
Similar to regular exchanges, these allow trading, speculating in rate differences and volatility of cryptocurrency.
More opportunities for those looking to make money
Derivatives that “lock in” the value of a cryptocurrency at a certain point in time, appeared in DeFi not too long ago. With derivatives, it is possible to achieve stability in the value of the cryptocurrency at the time of the transaction. In fact, this is a smart contract, which prescribes obligations to conduct the transaction at the price of cryptocurrency, which was in effect at the time of its conclusion.
Decentralized platforms actively attract users with additional ways to generate passive income. For example, at PancakeSwap, you can put native Cake tokens in a “syrup pool,” where they will earn good interest. You can also make predictions on the price of tokens (whoever hits closest takes the winnings), play a lottery game, or get into a free token giveaway.
The biggest risk is the volatility of the cryptocurrency. If it falls sharply in value, borrowers lose their collateral. When the value fluctuates, no matter which way the liquidity providers lose, there are risks of impermanent loss.
Besides, with a wrong platform chosen, there is a risk of running into a scam. Unscrupulous administrators collect money and close down. However, it is not that difficult to check the reputation of a platform in the crypto community.
Decentralized finance is characterized by three concepts:
On the other hand, it has no disadvantages of the traditional financial system:
- dependence on politics and the state;
- numerous intermediaries, each of whom tends to charge interest;
- absolute sensitivity of data;
- red tape and endless identity checks.
DeFi is still too young to expect stability and security. But the early adopters have a good chance of gaining a foothold in this market. Developers are creating new protocols and procedures, and users are trying to get richer. And judging by the fact that DeFi is already a $160 billion market, both are doing quite well.