A Complete Guide for Beginner’s on Decentralized Finance (DeFi)

A Complete Guide for Beginner’s on Decentralized Finance (DeFi)

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The financial industry is one of the most important and sensitive sectors today. As more and more people move finance from physical to digital, the financial industry is constantly looking for convenient and secure technologies that can be implemented to simplify workflows and enhance security.

Inspired by blockchain technology, decentralized financing, well known as DeFi, is a new way to manage finances in a decentralized way while completely eliminating the need for intermediaries. It gains attraction because of its benefits and features. By the end of 2019, the total value locked to DeFi was about $ 679 million, according to the DeFi pulse. But today, the total amount fixed to DeFi is $ 12.45 billion.

This article will answer most of the important questions about DeFi. Some of those questions are:

  • – What is Decentralized Finance (DeFi)?
  • – What are the differences of Decentralized Finance (DeFi) and Centralized Finance (CeFi)
  • – List of the advantages offered by Decentralized Finance (DeFi)
  • – The working of Decentralized Finance (DeFI)
  • – How to use DeFI?
  • – List of the leading DeFi Platforms
  • – The future of DeFi

List of the advantages offered by Decentralized Finance (DeFi)

DeFi stands for Decentralized Finance. This is a form of financing aimed at eliminating intermediaries and building the following financial ecosystem:

  • – Transparent
  • – Open Source
  • – Unauthorized
  • – Not centralized

A decentralized financial system works without a central institution. In other words, anyone can use it. Therefore, people can:

  • – Have full control of their assets
  • – Perform peer-to-peer transactions and exchanges
  • – Using and creating decentralized applications (dApps)

DeFi uses blockchain technology to facilitate finance by eliminating financial intermediaries such as stock exchanges, banks and brokers. With DeFi, people are able to::

  • – Lend money to each other
  • – Trading of cryptocurrencies
  • – Ensure against risk
  • – Attract high interest
  • – Speculate about asset price movements

Decentralized finance allows people to have a lot of benefits as well profit. But to better understand it, it is recommended to know the difference between DeFi and CeFi, Centralized Funding.

What are the differences of Decentralized Finance (DeFi) and Centralized Finance (CeFi)

The full form of CeFi is Centralized Finance. As the name implies, it is a structure governed by centralized financing.

The important difference between DeFi and CeFi is clear from the terminology itself. DeFi is decentralized, but CeFi is centralized. The DeFi network works in a way where permission isn’t necessarily required while CeFi is an authorized network where permission is must. This means that in CeFi only authorized personnel can perform certain actions, and in DeFi there is no person with central authority.

DeFi is open source. In other words, it encourages free collaboration. However, CeFi is not, that is, all decisions are made by certain authorized individuals and free collaboration is not enabled. Because DeFi is open source, that means that it is censorship resistant and CeFi can be censored.

DeFi is cheaper than CeFi because the only expense that DeFi requires is network charges. However, CeFi is relatively expensive because intermediaries charge high fees.

Defi is based on blockchain technology, but CeFi works in the same old and traditional way.

Decentralized finance is bringing a new dawn in the field of transactions that differs from traditional centralized financial systems by implementing P2P finance which is enabled by blockchain-based decentralized technologies such as Ethereum and Stellar. There are several central authorities, institutions such as banks and other intermediaries are involved in central finance and DeFi wants to eliminate it with the help of smart contracts.

Thanks to its many promising benefits, decentralized finance has become one of the most active sectors in the blockchain industry, with a variety of use cases and a total value of over $12 billion. Let’s cover all its benefits.

List of the advantages offered by Decentralized Finance (DeFi)

We all know that Decentralized Finance (DeFi) is based on Blockchain technology. This can also be said that DeFi has all the advantages that blockchain offers.
Some of the most important features of DeFi are listed below:

  • – Immutability
  • – Transparency
  • – Interoperability
  • – No single point failure

Immutability

It means that all the DeFi data is immutable that means can not be changed which is also supported by Blockchain. In DeFi all the information is tamper proof. It means that operations regarding financial procedure are highly secure.

Transparency

DeFi provides transparency. As we already know that DeFi works on blockchain technology, all transactions, data, and code on the blockchain are transparent to everyone. This level of transparency creates trust among users for everyone on the network for the following reasons:

  • – Nature of on-going transactions
  • – Smart contract

This transparency helps in ensuring:

  • – Trust
  • – Security
  • – Authenticity

Interoperability

Decentralized Finance offers various flexibility such as building on top of existing protocols, customizing interfaces, integrating third party applications. You can combine other DeFi products to create new decentralized financial applications. For example, stablecoin, decentralized exchanges and prediction markets can be combined with completely new and much more sophisticated markets.

No single point failure

Decentralized finance is based on blockchain technology. That is, all information is stored on the blockchain and distributed across multiple nodes. This eliminates all single points of failure. DeFi is censorship resistant and eliminates the possibility of service shutdown, as all data is distributed across different nodes.
In addition, DeFi also enables you to:

  • – Autonomy because you are solely responsible for your wealth and money on the DeFi network.
  • – Contract automation
  • – Fast transaction
  • – Low cost transaction

Now that we’ve covered multiple benefits of DeFi, let’s see how it works.

The working of Decentralized Finance (DeFI)

Decentralized finance works primarily with the help of three components-

  • – Decentralized application (dApps)
  • – Blockchain technology
  • – Smart contract

Decentralized applications perform financial operations on the blockchain. Smart contracts eliminate the intermediaries or central authorities commonly required for traditional forms of financial transactions. In smart contracts, transactions are done directly between two participants. DeFi protocol smart contract programs are run through open source software by a network of developers and programmers. Decentralize the financial process by eliminating the need for a central exchange. Many dApps can connect together and work simultaneously to create complex financial services.

The DeFi platform is based on the following features of blockchain technology:

  • – Reliable
  • – Tamper prevention
  • – Automation
  • – Can be programmed for cryptocurrency interactions

These properties allow you to create decentralized applications (dApps) to automatically interact with money in a variety of ways, without an intermediary or bank. A decentralized financial ecosystem will be more effective than:

  • – More dApps are being built
  • – Increases integration with each other

The current innovation in the DeFi ecosystem is yield farming, also known as liquidity mining. Yield farming is a way to reward users in the following ways:

  • – Providing liquidity in the dApp ecosystem
  • – Providing other value-added services for dApps

Yield agriculture often envisions two main goals.

  • – To motivate users to deposit liquidity and lock into DeFi applications
  • – Fairly distribute DeFi app governance tokens to log users

Various DeFi protocols usually choose other methods to achieve high yielding agriculture, depending on the goal.

Now that we know about the idea of how DeFi works, let’s go around some of its uses.

How to use DeFI?

There are several DeFi use cases today. You can implement decentralized finance in multiple industries for a simple, fast, and convenient workflow. Here we have listed some of the ways in which we can use decentralized finance.

  1. Data and analysis
  2. Borrowing and lending
  3. insurance
  4. Identity
  5. payment
  6. Stablecoin
  7. Exchanges and markets

Let’s look at them in details

1. Data and analysis

Decentralized financial protocols allow efficiency in various fields such as data analysis, decision making regarding finance and risk management. This is possible because it is based on blockchain technology and it provides transparent access to all transaction data and network activity. With the increase of the DeFi dApp application, numerous tools and dashboards have been developed that allow users to track total values and compare risks on different platforms.

2. Insurance

Decentralized financing is a concept that is still emerging and evolving. There are some risks associated with smart contract bugs that need to be considered before implementing them in sensitive sectors such as insurance. After implementing DeFi can greatly benefit the insurance industry from increased transparency, reliability and security. Numerous innovative alternatives have been introduced to help people get insurance and protect their wealth.

3. Payments and Monetary Banking Services

Financial use cases such as payments and banks are the main use cases for decentralized finance and blockchain technology. Because blockchain allows users to exchange cryptocurrencies securely and directly without intervention, DeFi Payments creates payment and banking systems such as:

  • – open minded
  • – user friendly
  • – Accessible

DeFi payments are also useful for financial institutions.

  • – Market infrastructure optimization
  • – Providing better service to wholesale and retail customers
  • – Reach people more systematically

Many intermediaries and intermediaries are involved in traditional payment and banking services. Therefore, the process is very tedious, time consuming and costly. When using DeFi payment:

  • – You can activate Peer-to-peer payments so you can pay directly.
  • – Smart contracts can automate the process and eliminate intermediaries.
  • – Payments and banking services can be relatively cheap.
  • – Prompt payment and process are guaranteed.

4. Stablecoins

Cryptocurrencies associated with fiat currencies and stable assets such as gold are called stablecoins. Originally created to stabilize the ever-changing prices of cryptocurrencies, Stablecoin for decentralized finance can be implemented for the following purposes:

  • – loan
  • – lend
  • – Central Bank Digital Currency (CBDC)

Stablecoin keeps a specific value rather than constantly changing the blockchain, so you can create a viable blockchain for payments. Stablecoin usually falls into three types:

Crypto-Collateralized Stablecoin

Stablecoins which are backed by crypto assets in the form of collateral are known as Crypto-Collateralized Stablecoins

Fiat-Collateralized Stablecoin

Coins that store their value in fiat currencies such as the euro and the US dollar are known as fiat-backed securities. They are usually redeemable 1: 1 in the fiat currency in which they are fixed.

Non-Collateralized Stablecoin

Stablecoins that are not centralized and are not overly protected by crypto assets are called unprotected stablecoins. According to the algorithm, the system delivers more tokens at a lower price when demand increases, and less tokens at a higher price when demand decreases.

Many brokers, intermediaries and middlemen are involved in traditional payment and banking services. Therefore, the process is very long, time consuming and costly. When using DeFi payment:

  • – You can enable peer-to-peer payments to enable direct payments.
  • – Smart contracts automate the process and eliminate intermediaries.
  • – Payments and banking services can be relatively cheap.
  • – Prompt payment and process are guaranteed.

5. Exchanges and Marketplaces

Decentralized exchanges include peer-to-peer transactions between two parties in the blockchain without the involvement of an intermediary or intermediary. Therefore, they are quite different from other centralized exchanges. The DeFi protocol supports a variety of online marketplaces which allow users to exchange various products and numerous services globally and directly (P2P).

Some of the benefits of implementing DeFi on exchanges and markets are:

  • – No registration
  • – No ID check
  • – No withdrawal fee

List of the leading DeFi Platforms 

In recent years, the blockchain industry is growing at an unimaginable rate and with it the cryptocurrency, and decentralized finance plays a major role in it. Everyday a new kind of DeFi platform is being built to support various uses to bring transparency and security.

Some of the leading DeFi platforms are:

  • – Uniswap
  • – Maker
  • – Compound

Uniswap

Uniswap is a decentralized exchange platform based on the Ethereum network. Uniswap uses the liquidity pool for token swaps without limit orders.
With the Uniswap platform, users can:

  • – Exchange ERC20 tokens
  • – Providing log liquidity
  • – Earn commissions while providing liquidity-Every user who provides liquidity receives a 0.3% commission proportional to the – amount of liquidity they offer.
  • – Add liquidity to an existing pool
  • – Create your own liquidity pool-Users only need to provide a pair of tokens to the market to build a liquidity pool in Uniswap.

Market makers use Uniswap’s “Constant Product Market Maker” mechanism to set exchange rates. This mechanism distinguishes Uniswap from other decentralized exchanges. This is a pricing mechanism that allows users to add any token to Uniswap by raising funds with ETH and ERC20 tokens that trade at the same value.

Maker

MakerDAO is based on Ethereum and is a decentralized credit and credit platform. DAO stands for Decentralized Autonomous Organization and is maintained by MKR Governance Token holders. You can determine the future of the protocol by agreeing or disagreeing with the platform change proposal.

The owner of the MKR regulates the minutes voting system and makes decisions on the following changes:

  • – Risk parameters
  • – Add assets
  • – Stable charge amount

Maker creates DAI, a stablecoin used in most major DeFi projects. You can use Maker to:

  • – Create a vault
  • – Block crypto collateral
  • – Create DAI as debt to collateral

Both MKR and DAI are ERC20 tokens. Maker also offers over-collateralized loans at DAI with up to 66% of collateral value.

MKR acts as a collateral base for the platform and all transaction fees on the platform are paid in MKR. Burned in response to DAI price fluctuations to maintain the dollar peg and use it as a governance token.

Compound

Compound is an Ethereum-based algorithmic money market protocol. Compound allow users to: 

  • – Lend assets to earn liquidity 
  • – Secure your own cryptocurrency and take out a loan 
  • – cToken represents a credit and can be used to earn interest 
  • – As a safety, Users can borrow over-collateralized loans at Compound to borrow up to 75% of the original collateral. Unsecured loans / debts can be easily liquidated  and collateral can be easily added or removed. 

The composite protocol has been reviewed and formally validated. It also supports multiple assets. Originally introduced in September 2018, it was upgraded and implemented  in May 2019. A year later, in May 2020, the platform was decentralized by making governance features available to COMP token holders.

The future of DeFi

Crypto is a digital offer that revolutionizes all industries with its benefits. In the future, it can be assumed that the majority of financial service providers will implement DeFi on their systems. Currently, the DeFi app uses collateral as a security mechanism for credits and credit transactions. DeFi has the potential to be a major source of revolution in the insurance industry.

In addition, as more and more people move to decentralized ways to do business and transactions, we anticipate a significant shift to “decentralized governance” and “decentralized decision making.”

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