If you’re involved in the crypto space, you’ve probably heard of DeFi. This has been one of the major buzzwords of the fintech world in 2019. DeFi is not a blockchain application, even though it sounds like it would be. It’s actually an abbreviation for the term decentralize finance.
The ethos behind the concept is simple, take value out of the hands of banks, governments, and other middlemen and empower the individual to take control of their own finances.
From a technical standpoint, saving more value for the individual and keeping that money in their pockets means two things. First, all of the technical tools currently embedded within the ecosystem of decentralized technology get put to good use. Secondly, developers and users alike continue finding new ways to make achieving a truly decentralized financial system easier. The goal is to make spending, investing, and borrowing seamless in practice and completely democratic in structure.
Which Blockchains Use DeFi?
There are over 20 different blockchain projects currently helping people take control of their own finances. The majority of DeFi projects are executed on the Ethereum blockchain. Ethereum is dedicated to becoming the world’s largest decentralized computer. It allows developers to fund their own applications, build them, and share them with the world, without needing a big tech intermediary like Google or Apple to facilitate innovation, publishing, or marketing.
At this time, there’s only one blockchain project on the Bitcoin network that relates to decentralized finance, The Lightning Network. This is a second layer of code on top of the Bitcoin blockchain that allows for the creation of smart contracts, which are self-executing contracts that eliminate the need for a third-party to oversee transactions. This makes transactions more cost-effective. The Lightning Network also accomplishes the following:
- Instant Payments: Lightning Network can be used at point-of-sale terminals to facilitate a transaction on the spot. This makes it easy and practical to use Bitcoin for everyday purchases.
- Micropayments: Lightning Network allows for transactions as small as 0.00000001 BTC to be confirmed on the blockchain. This makes it easy to pay for consuming content or to send the spare change to a friend or merchant.
- Scalability: The scalability implementation within the Lightning Network makes it possible for two parties to make unlimited transactions between devices off-chain. Only the final outcomes of a transaction go on-chain. Say hello to efficiency!
Types of DeFi Projects
Many other significant DeFi projects in the blockchain world are hosted on the Ethereum network. These projects intend to make access to assets easier for everyone, ensuring that there is enough liquidity to go around. The endgame is to make things as seamless as possible and to make cryptocurrencies and blockchain tech easier to use.
Those projects fit into five different categories:
- Decentralized Exchanges
MakerDao is by far the most popular DeFi project on the Ethereum network. Currently, there are over $309 million in user funds locked into the project. The project itself is a decentralized credit platform that supports DAI.
DAI is a stablecoin with value that is attached directly to the U.S. dollar. It allows anyone who uses MKR to open a Collateralized Debt Position (CDP). This means they lock in ETH and generate DAI as debt against the collateral. In other words, the user gets to borrow money. DAI debt incurs a stability fee, which is paid in MKR tokens upon the repayment of the DAI being borrowed.
Users can borrow up to 66% of their collateral’s value (based on a 150% collateralization ratio). CDPs that fall below that rate are subject to a 13% penalty and liquidation to bring the CDP out of default. Liquidated collateral is sold on the open market at a 3% discount.
Decentralized Exchange Projects
The top decentralized exchange projects on the Ethereum blockchain include Uniswap, Bancor, and Kyber. Out of the $33 million in fines locked into the three projects, over two-thirds of that value is just in Uniswap.
Uniswap is a fully decentralized on-chain protocol that uses liquidity pools instead of order books to facilitate transactions. Anyone can trade between ETH or any other tokens that use the ERC-20 protocol. Traders can also earn fees by providing added liquidity to the market and lending their own tokens to the exchange.
Uniswap doesn’t have a native token, but each trading pair is represented by a freely transferable ERC-20 token. All trading fees are added to the appropriate trading pool, and that fee usually ranges around 0.3% on a trade.
A derivative is essentially a synthetic asset that represents a real-world asset. Creating these kinds of assets on the blockchain gives users access to real-world markets while providing the security that comes with a decentralized network.
Synthetix controls almost $88.5 million in funds and represents 20 different synths connected to cryptocurrencies, fiat currencies, and commodities. The project intends to introduce stocks and indices in the future.
Other derivatives based projects include predictive markets, one of the most popular use cases for blockchain projects. Augur is a popular peer-to-peer project in that space. It allows anyone to create a market surrounding a real-world event. Given gambling is one of the most popular uses for crypto, these kinds of markets have continued to thrive.
The Lightning Network handles $7.7 million worth of payments at any given time and is the only payment network that’s on the Bitcoin blockchain.
There are two payments projects on the Ethereum network: xDai and Connext. xDai is a sidechain project with five-second block times and low gas costs. It is associated with the POA Network and MakerDao. Connext essentially allows users to load a card with value and use that value instantly.
WBTC is an ERC-20 token backed by Bitcoin. The idea behind it is to bring the vast liquidity available on the Bitcoin network to Ethereum. WBTCs are traded on both decentralized and centralized exchanges. Users can swap WBTC through eight different merchants. Swapping assets does require customers to go through Anti-Money Laundering (AML) and Know Your Client (KYC) procedures. This initiative is run by a decentralized autonomous organization and is supported by 16 different projects that all have an interest in decentralizing finance. These include Dharma, MakerDao, Set Protocol and Compound.
The Future of DeFi
The world of decentralized finance exists to continue the mission of providing users with democracy and agency over their value and to make the cryptocurrency market more stable and accessible. That means making it accessible to consumers, merchants, investors, and institutions. Innovation is propelling DeFi into real-world use cases, giving the technology the avenues and potential to impact the world.