Decentralized finance, or DeFi for short, has taken the world of crypto and blockchain by storm. However, its recent resurgence has masked its roots in the 2017 bubble era. While everyone and their dog were doing Coin Initial or ICO, few companies saw the potential of the blockchain far beyond the rapid rise in price. These pioneers envisioned a world in which financial applications from savings to savings to banking and insurance would be possible simply in a blockchain without any intermediaries.
To understand the potential of this revolution, imagine if you have access to a savings account that carries 10% per year in US dollars, but without a bank and virtually no risk of funds. Imagine being able to trade harvest insurance with a Ghanaian farmer sitting in your Tokyo office. Imagine being able to be a market maker and earn fees as a percentage that any Citadel would want. Sounds too good to be true? Not so. This future is already here.
DeFi building blocks
Here are some basic DeFi building blocks you need to know before moving on:
Automated market creation or hopeless exchange of one asset for another without an intermediary or clearing house.
Over-secured lending or the ability to “use your assets” for traders, speculators and long-term holders.
Stable coins or algorithmic assets that track the price of an underlying asset without being centralized or backed by physical assets.
Understanding how to make DeFi
Stablecoins are often used in DeFi because they mimic traditional fiat currencies such as the USD. This is an important development because the history of crypto shows how unstable things are. Stable coins such as DAI are designed to track the value of the USD with minor deviations even during strong bear markets, ie.
Loan protocols are an interesting development, usually built on stable coins. Imagine if you could lock up your million-dollar assets and then borrow against them in solid coins. The protocol will automatically sell your assets if you do not repay the loan when your collateral is no longer sufficient.
Automated market makers form the basis of the entire DeFi ecosystem. Without that, you are left with an inherited financial system where you have to trust your broker, clearing house or stock exchange. Automated market makers, or AMM for short, allow you to trade one asset with another based on a reserve of both assets in its pools. The opening of the price is done through external arbitrators. Liquidity is pooled based on other people’s assets and they gain access to trading fees.
You can now get exposure to a wide variety of assets, all in the Ethereum ecosystem and without having to interact with the traditional financial world at all. You can make money by borrowing assets or as a market maker.
For the developing world, this is an incredible innovation because they now have access to the full range of financial systems in the developed world without barriers to entry.