What is DeFi
So, what is DeFi, and how does it work? DeFi, or Decentralised Finance, is the cryptocurrency or the blockchain world’s attempt to disrupt the traditional finance and banking sectors. Sometimes, we also refer to DeFi projects as financial applications. We know that currently, the most popular DeFi blockchain is Ethereum. This is why most of these projects are built on this specific decentralised blockchain technology. These blockchain technologies make use of smart contracts to execute and enforce the terms and conditions of the agreement. No middlemen or intermediaries are required to execute the terms of the contract, thus it is trustless. Most of these DeFi applications are usually accessible by anyone with an internet connection.
DeFi platforms such as Celcius Network, allow people to lend or borrow funds from others, speculate on price movements on a range of assets using derivatives, trade cryptocurrencies, and earn interest in savings-like accounts. Some DeFi projects promote extremely high-interest rates but are subject to high risk. As of May 2021, the TVL (Total Value Locked) in USD was $79,55B, or roughly 16.59% of the total DeFi market. DeFi Pulse is a great place to find the latest analytics and rankings of DeFi protocols.
Total Value Locked in DeFi (source-Defi Pulse)
How does it Work
The way DeFi apps work is, they use decentralised apps (or dApps) that run on an immutable ledger or blockchain. This blockchain (like the one Bitcoin was built on) then performs certain financial functions, which are specific to a smart contract. Typically, DeFi apps are built on the Ethereum protocol. Ethereum has proven to be the most scalable platform with the most developers to date. However lately, more and more projects are beginning to build on other protocols such as Polkadot, Cardano and Solano to name a few.
These days, there are many different types of DeFi apps out there and they can get rather complex. A few common types include Lending Platforms, Decentralised Exchanges (DEX’s) and Yield Farming.
One such example of a DeFi protocol (a DEX, in this case) is Uniswap (UNI). Uniswap, as its name implies, is a decentralised exchange where different tokens can be exchanged or swapped. You can access the uniswap app via a web 3.0 browser extension or application such as Metamask wallet. We have a detailed How-to guide on Metamask Wallet here. Users can then directly interact with the Ethereum blockchain via the uniswap app.
See DeFi work in real life, with Uniswap and Metamask.
DeFi Examples
Lending Platforms. These platforms allow you to stake crypto and fiat (in some cases) against which you can then borrow money. Examples f these platforms include platforms such as Nexo, Ledn, BlockFi and Celsius Network. You can also take a look at Yield App, which allows you to invest and save but not does yet allow you to borrow against your collateral. Our full review of the NEXO Lending platform can found here.
DEX’s, or Decentralised Exchanges. Some of these include Uniswap, Pancakeswap and Sushiswap. We will take a detailed look at Uniswap in the next section.
Yield Farming. Yield farming allows you to stake or invest your crypto for a return on investment or yield. Rewards or interest in yield farming is often earned in more crypto. However, yield farming often also involves moving your crypto around all the time between different marketplaces to maximise your return. Examples of these include Yearn Finance, Venus and Pancakeswap again.
Derivatives. We won’t go into too much detail with derivatives for now. basically, these protocols, such as Synthetix, allow you to gain on-chain exposure to a vast range of assets. Synthetix, the derivatives liquidity protocol, calls itself the backbone for derivatives trading in DeFi.
Celcius Network -Download the app
Uniswap
Why DeFi
So why is it that the DeFi market has been so popular of late? Well, while regulators have been struggling to keep up, the DeFi market has been flourishing. For example, in traditional finance, there is a lot of legal requirement for both the lender and borrower. The borrower needs to know the lender’s identity as well as determine his ability to repay. This process is known as KYC (Know Your Customer) and credit scoring.
While, in the DeFi space, this is not required. The entire transaction is built on smart contracts which execute upon certain predetermined parameters. In other words, it is a trustless, immutable (unchangeable) system.
The second reason is the major adoption by institutions of DeFi and major cryptocurrencies like Bitcoin and Ethereum. The most prominent of the institutions is the Asset management firm, Grayscale, the worlds largest crypto fund. They now hold over total Assets Under Management (AUM) of approximately $50 Billion.
Conclusion
While we are definitely headed for a new financial system in the future, we do expect regulation to be tightened down on DeFi and crypto as a whole. Traditional finance and regulators would be better served to try and work together with the decentralised DeFi space.
Regulation isn’t all bad for the consumer. DeFi is still a risky play for the most part. A lot of people still don’t know how it works. Mostly, people tend to lose some money before they get past the learning curve. The other issue with an unregulated market is, there are always scammers out there trying to scam people out of their money.
So do your research and due diligence and you should be fine. You should just try to get involved. Try staking some crypto, try getting a crypto-backed loan, even if it’s only $100 or $200. The point is, just get involved. Because this space is evolving quickly and it isn’t going anywhere but mainstream.
Exchanges that we use:
- Binance
- Bittrex
- Kucoin
- Poloniex
- CEX
- Altcointrader (Check out our review of Altcointrader.co.za here)
