All You Wanted To Know About Decentralized Finance

The last few years will certainly need chapters of their own in the historical books. But beyond the pandemic crisis and economic instability, we have also seen a few trailblazing projects taking off the ground. Blockchain, in particular, has been the technology of the hour that gained unprecedented traction in 2022. 

Decentralized finance or DeFi now accounts for a lion’s share of blockchain popularity with over $77 billion locked in DeFi protocols. Each day, new DeFi applications are being launched to further widen the crypto ecosystem. But what is DeFi cryptocurrency? And is it worth your time in 2022? Read on to find out.

Where DeFi Comes From

Decentralized finance, or DeFi for short, is an umbrella term that encapsulates various financial services delivered over a blockchain. While there are many types of DeFi products, they all have one key thing in common: they’re decentralized. That means no third party holds custody of your funds and you’re in control of your assets at all times.

This term is a brainchild of Ethereum developers and entrepreneurs that were brainstorming the name for a new movement of open financial applications on Ethereum. Open Horizon, Lattice Network, and Open Financial Protocols were also among the potential names for decentralized finance. 

Today, we can say that this name was set up for success. Thus, there are currently around 238 DeFi applications, the majority of which run on the Ethereum ecosystem.

How does DeFi work?

As its name implies, decentralized finance is an antagonist of traditional centralized systems. DeFi products operate without third-party involvement or a bank monitoring and approving your transactions. Instead of financial intermediaries, all processes are automated and executed through smart contracts.

Smart contracts fuel the back-end of any decentralized application built on Ethereum. In simple words, these are codes or programs that are automatically executed when predefined conditions are met.

Why does it matter?

The market capitalization of DeFi products equated to around $80 billion at the end of July 2021. While it was a downward trend, analysts predict the figure to climb in the coming year as the DeFi maturity increases. 

The long-run vision of decentralized finance involves building a full-fledged and fully-automated trustless financial system. In particular, the DeFi ecosystem can provide anyone with easy and fast access to traditional financial services, eliminating the need for intermediaries. Unlike traditional systems, DeFi has lower entry barriers, thus being for far-flung areas with unstable economies. DeFi services are also in demand in developed countries, especially in the areas of lending, investment, and the development of new revenue models.

Other crucial advantages of blockchain-based finances include:

  • Transparency – being based on the blockchain ecosystem, DeFi services make all transactions visible to any DeFi user, thus promoting trust across the network;
  • Security – decentralized systems bring the control over funds back to the users since no intermediaries are needed to monitor the transactions;
  • Interoperability – new DeFi applications can be created by combining other DeFi products (stablecoins, decentralized exchanges, prediction markets, etc.). This feature of DeFi resembles a model where a certain structure is a result of various combinations (much like a Lego house).

Top Real-life DeFi applications

By this time, you must be invigorated by this new, trailblazing way of handling your finances. However, the DeFi ecosystem doesn’t boil down to performing transactions, it also encompasses a wide range of other use cases that are gaining momentum in 2022. Let’s have a look at the most common applications of decentralized finance services.

Lending

Open loans are by far one of the most widely-known applications within the DeFi ecosystem. Unlike centralized systems which include long approval procedures and credit checks, DeFi platforms connect borrowers directly with lenders. To get a loan, the borrower doesn’t need physical collateral such as a car or a house. Instead, a user can offer cryptocurrency of at least equal value to the loan amount. Lenders, in turn, benefit from lending crypto assets by capitalizing on the interest amounts. 

Aave is a prominent example of a lending protocol that enables users to supply and borrow crypto assets. Lenders, at the same time, can cash on a return they offer to the protocol. 

GameFi or Play-to-Earn

GameFi is one of the hottest applications in the blockchain field. Also known as a ‘play-to-earn’ model, GameFi merges the best of gaming and blockchain-enabled financialization. As such, this model offers exactly what it refers to – earning crypto assets through in-game efforts. However, unlike traditional play-to-earn games that can strip users of their investments once the game is down, GameFi enables users to keep their assets on a distributed network. It means that plays can use their earnings across the entire system, including other blockchain-based games.

Based on NFT assets, Forest Knight is a turn-based strategy game that attracts users by offering unique digital collectibles in exchange for gaming activities. The game currently has 25 NFT types. As of March 2022, the 24h trading volume of Forest Knight amounts to $225,319.

Yield Farming

Liquidity mining or yield farming now accounts for the largest share of popularity with the Compound project making it to the top DeFi trends. The number of cryptocurrencies locked in DeFi now stands at over $80 million. The investment strategy of yield farming includes benefitting from cryptocurrency deposits on various DeFi cryptocurrency platforms. This earning model allows for up to 100% annualized returns. 

UniSwap, Curve.Finance and SushiSwap are among the most popular liquidity providers. All of them operate across different chains, with SushiSwap offering classic lending without automated-market-makers. 

Synthetic assets

Crypto synths refer to tokenized derivatives that inherit their value from the underlying assets through smart contracts. Cryptocurrency-based synthetic assets aim to give users access to many different assets without having to hold the underlying asset. 

Crypto synths usually come in the form of ERC-20 smart contracts that run on the Ethereum blockchain. The main differentiator of these projects is that they allow investors to trade anything on the blockchain without owning a specific asset.

Synthetix is the largest and most well-known synthetic asset exchange. Synthetix is a market leader in this niche sector because it was one of the first exchanges in the world to be specially designed for trading tokenized derivatives. Cream Finance and MakerDAO are two prominent Synthetix alternatives.

As you can see, the DeFi landscape is a vibrant and emerging market with ever-evolving applications and use cases. Being a new kid on the block, decentralized finance is poised to become a transformative power that lays the foundation for an open, more accessible, and tech-driven financial system.

The Future of DeFi

Despite certain twists and turns, DeFi has made a dent in the market with resilient total locked value and a rich application field. As the technology is still in its infancy, it’s impossible to predict the future of decentralized finance and blockchain as a whole. Yet, even if they don’t end up dominating the centralized financial world, DeFi and blockchain still hold great promise to reset our perspective of financial accessibility and to innovate the traditional financial services.

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