When it comes to the creation of next-generation financial products, the Decentralized Finance (DeFi) movement does just that. By leveraging open source software and decentralized frameworks, DeFi aggregates a suite of tools and products that allows anyone in the world to utilize financial services in a trustless and transparent manner. Simply put, DeFi aims to remove all intermediaries to provide the world with a globally inclusive financial system.
“One could envision decentralized finance impacting the financial world the same way that open source software has changed software products.”
Below, we have created a high-level introduction to the different DeFi sectors and highlighted a few of the prominent projects in each sector. You can also read our What is DeFi beginners guide that helps explain the basics of Decentralized Finance and how to get started.
DeFi allows any individual to take out or supply a loan without approval from a third party. As such, the large majority of lending products tend to use popular cryptocurrencies such as Ether ($ETH) to secure outstanding loans. Seeing as digital assets have been known to exhibit strong price volatility, it’s common practice for lending platforms to require borrowers to supply an average of 150% collateralization to initiate a loan. Furthermore, the advent of smart contracts allows for maintenance margins and interest rates to be programmatically encoded into an agreement. As such, liquidations occur automatically if one’s account balance falls below a specified collateral ratio. To date, lending has dominated as the leading DeFi use-case.
Projects in the lending space include but are not limited to:
- MakerDAO – MakerDao Review
- Compound – Compound Finance Review
- dYdX – dYdX Review
- Nuo Network – Nuo Network Review
With the programmable Store of Value (PSoV) proposition in mind, it’s no surprise that digital assets based on different protocols are looking to leverage the benefits Ethereum’s blockchain provides. DeFi tools provide the foundation for assets such as bitcoin ($BTC) to be represented as ERC-20 tokens. In practice, the process of wrapping allows for digital assets ($BTC) to be secured by decentralized custodians and represented as a new token ($WBTC) which holds the same value as the underlying collateral.
The DeFi movement can encompass a range of other tokenized assets. Given the open and permissionless nature of DeFi, tokenized real estate allows any prospective investor to participate in the residential and commercial real estate market. Investors could own a single ERC-20 token representing ownership in the underlying property and receive daily rent payments in the form of a stablecoin.
Projects in the asset space include but are not limited to:
In traditional finance, a derivative represents a contract where the value is derived from an agreement based on the performance of an underlying asset. There are four main types of derivative contracts: futures, forwards, options, and swaps. With the advent of DeFi, investors can now benefit from open, transparent and automated settlements for derivative contracts. Smart contracts can issue tokenized derivative contracts allowing investors to employ derivative trading strategies for crypto assets and gain exposure to both sides of the asset’s performance.
As you can imagine, being able to “program value” creates endless opportunities for developers. Another perfect example is algorithmically managed assets. With DeFi, users can hold a single ERC-20 token to represent a diversified portfolio fully backed by the underlying crypto assets. Most importantly, all of these tokens operate in a completely permissionless and open fashion naturally embedded in the DeFi movement.
Projects in the derivatives space include but are not limited to:
In order for DeFi to be successful, it’s crucial that the gateways for interacting with web 3.0 are intuitive, secure, and accessible for any user while maintaining the core nature of “be your own bank”. Asset management tools, such as non-custodial wallets, fit this bill perfectly and are vital in progressing web 3.0 to the mainstream. Over the past few years, we’ve seen drastic improvements to wallets and other asset management tools, allowing investors and users to safely and easily access the next generation of financial technology.
Projects in the wallet space include but not limited to:
- MetaMask – MetaMask Review
- Argent Wallet – Argent Wallet Review
- Coinbase Wallet – Coinbase Wallet Review
- Burner Wallet
- Trust Wallet
- Gnosis Wallet
As any experienced trader knows, centralized exchanges pose a huge risk as it relates to custody. It has happened countless times before where a centralized exchange gets hacked and traders lose millions in capital. With this in mind, the average trader is more than willing to take this risk thanks to the amount of liquidity centralized exchanges are able to provide. Moving forward, DeFi aims to provide the crucial bridge that many Decentralized Exchanges (DEXs) have lacked to date.
In short, decentralized exchanges allow users to swap their digital assets without having to transfer custody of the underlying collateral. DeFi DEXs aim to provide trustless, interoperable trading across a wide range of digital asset markets. Depending on the specific DEX in question, users may benefit from anonymous transactions, automatic order matching and/or profit sharing.
Projects in the DEX space include but are not limited to:
Since the inception of crypto, we’ve seen numerous instances of users losing funds whether it be through exchange hacks, compromised private keys, or simply mishandling their crypto funds. For the most part, given the decentralized nature of the technology, there is no credit card company or bank to call up to reverse the transaction or to retrieve the funds. Therefore, the importance of insurance in the DeFi movement is crucial for bridging this growing need.
Decentralized insurance protocols allows users to take out insurance policies on smart contracts, funds, or any other digital asset through pooling individual funds to cover any claims. This area of the DeFi sector is rather small but we’ll begin to see more and more insurance application arise as the need continues to grow.
Projects in the insurance space include but are not limited to:
With the large majority of digital assets being subject to extreme price volatility, everyday use-cases surrounding mediums of exchange can be difficult to implement. As such, the recent emergence of stablecoins provide a solid foundation to mitigate price volatility while leveraging the inherent value digital assets provide.
Unlike traditional fiat currencies, stablecoin issuance is fully transparent with reputable projects being fully collateralized and in some cases, completely trustless.
In short, stablecoins are pegged to a predetermined value (most commonly $1USD) with different collaterlization systems in place to ensure that the asset always maintains its peg price. As it relates to DeFi, two currencies have emerged as the standard stablecoins of choice:
Other stablecoins in the industry include but are not limited to:
DeFi stands for Decentralized Finance. The DeFi movement has also been referred to as “Open Finance”
DeFi provides a suite of tools to allow any individual anywhere in the world to partake in financial services while retaining full custody of the asset(s) in question. Furthermore, DeFi aims to unlock trustless interactions with financial products in both peer to peer and pooled fashions.
While many Ethereum-based projects have deep-seated finance roots, the official term #DeFi was coined in Q3 of 2018.
Ethereum has quickly emerged as the defacto platform for DeFi thanks to advanced smart contract scripting and sophisticated token standards. Furthermore, Ethereum has the largest number of active developers with a solid foundation of wallets, exchanges and communities to build on top of.
Many DeFi tracking sites use Total Locked Value (TVL) as a reference point. Simply put, TVL represents the amount of assets that are currently being staked in a specific protocol. This value is by no means meant to represent the amount of outstanding loans, but rather the total amount of underlying supply being secured by a specific application and/or by DeFi as a whole.
The large majority of DeFi projects utilize web 3.0 wallets such as Metamask, Ledger Nano S or Coinbase Wallet. Simply create your own wallet and transfer a small amount of supported digital assets such as Ether ($ETH), US Dollar Coin ($USDC) or Dai ($DAI) to said wallet to get started!
It’s important to note that for the large majority of DeFi products, you must retain custody of your assets to utilize their services. This means that wallets that live on secondary exchanges such as Binance or Coinbase will not suffice.