Let’s discuss one of the hottest topics in the Crypto space.
DeFi is a fast-growing industry in Decentralized Finance. It is one of the fastest-growing trends on the Blockchain.
Traditionally, finance, money markets, and the economy, in general, are centrally controlled by the power of central banks located in almost every country in the world. These central banks are responsible for issuing the currencies that drive economies.
The major problem here is that since these central banks control the creation and issuance of money when a problem arises, the risk is also pivotal, and that risk is fundamental.
What could go wrong, you ask? What if, during a time of financial crisis, these central banks decide to print lots more money (remember fiat does not have the backing of Gold, Silver, or any other precious metal) and this flood of currency backfires?
Recall if you will, Venezuela, and the massive inflation of 1,000,000% they recently experienced. In their efforts to try to deal with the oil price drop, and the effect it was having on the economy, a massive influx flood of currency was printed and issued by the central banks. This error in human judgment destroyed the economic balance.
Then there is the issue of depositing your hard-earned cash into savings programs with a bank, and they, in turn, from these funds issue high-interest loans. These loans generate a high return of profit for the bank, yet, you receive a minimal amount of this interest profit. Due to world-wide inflation hovering around 3.5% (about 2% in the USA), this profit returned to you becomes less valuable.
Some of us choose to invest. So we seek a broker or financial officer to advise us on investing our cash in mutual funds, share markets, and other schemes in return for a portion of our profit. If these ventures are successful, the return on investment is higher. However, these advisors, being human, oft times fail to see some market risks and make mistakes that result in loss of profit, which proves to be costly to us.
In comparison to the wealthy, the average middle-class person owns fewer shares in companies. Although that number has grown since 2017, it remains disparate. The fact is, there are people in some countries who never even have the opportunity to access the stock market.
We have very little control over investments of our money due to the lack of transparency in the global financial market. But aren’t cryptocurrencies supposed to change all that? Bitcoin and other early cryptocurrencies do offer a way to sell, buy, and trade without the need of intermediaries, therefore, eliminating banks and other financial institutions for settling transactions. However, they have not decentralized the financial system. They have just decentralized the issuing of money and its storage. A couple of issues remain to overcome, which prevents the blockchain from becoming completely decentralized.
- Even though cryptocurrencies are decentralized, they remain accessible on centralized exchanges.
- Most of these crypto projects use centralized companies that lack accountability or transparency to manage these projects.
It seems we are still trusting in banks and fintech firms to manage our funds. However, decentralization and transparency of the blockchain with the creation of DeFi (decentralized Finance) and it’s products, they have a goal to eliminate these issues.
What Makes DeFi Different?
DeFi can offer you control over what happens with your assets. You decide! It can do this because DeFi is decentralized, and through transparency and blockchain technology, you can know what is happening with your assets at any time. Additionally, many developers are adopting their apps on the “open source” protocol for use in trading on decentralized platforms. Open source protocol allows anyone to use and build new and better products utilizing this technology freely. Developers across the world can then collaborate to create more security and better innovation into their products.
Collectively the products of DeFi are known as “open finance.” DeFi includes such things as smart contracts, digital assets, protocols, and Dapps. Given the flexibility, and the amount of development, the Ethereum platform is the platform of choice for DeFi products; however, it is not the only choice.
Some of the products offered through DeFi’s Ecosystem include:
Open Lending Protocols
Read more about these here: https://blockgeeks.com/guides/demystifying-defi-ultimate-guide/
“As the name suggests, this is a digital money lending platform built on a blockchain. Open Lending Protocols have probably become the most popular among other open finance sectors in recent years, thanks to the recent extensive use of Dai, other peer-to-peer protocols such as Dharma, and liquidity pool designs such as Compound Finance...”
“Unlike other crypto coins which have a volatile value, stablecoins are blockchain-issued tokens designed to hold on to a specific value. This is usually done by pegging it with fiat currencies like the US dollar, but oftentimes with other assets like gold. Stablecoin incorporates collateral to accommodate for the price variation...”
“Stablecoins can be primarily categorized into 3 types:“
Exchanges and Open Marketplaces
“Unlike centralized exchanges, such as Coinbase, decentralized exchanges have peer-to-peer transactions of digital assets between two parties on the blockchain with no third-parties involved. The advantage of this approach is that there are no sign-ups, no identity verification, or any withdrawal fees..”.
Issuance and Invest Management Platforms
“This sector covers a broad range of platforms. A significant portion of issuance platforms is honing in on the security token market. This platform also includes exchanges like tZERO from Overstock, which also acts as issuance mediums...”
How Decentralized Is DeFi ?
This information is courtesy of https://blockgeeks.com/guides/demystifying-defi-ultimate-guide/ and is important facts to know so it is copied direct.
In crypto space, it is said –
“A system is decentralized only as its most central component.”
This is part truth since decentralization exists in sequence and on multiple levels. The degree of decentralization in DeFi services varies since neither every component can be decentralized nor it should be.
For example, let’s talk about categorizing decentralized Lending Protocols which can be done based on common components all DeFi lending protocols, such as custody, price feeds, provision of margin call liquidity, initiation of margin calls, protocol development, and interest rate determination.
Degree 0 Defi aka CeFi: Centralized Finance (CeFi) products are custodial in nature, use centralized price feeds, and initiate margin calls, provide liquidity for their margin calls, and centrally determine interest rates all centrally.
Examples – BlockFi, SALT, Celsius, Nexo.
Degree 1 DeFi: These categories of DeFi products are non-custodial but use centralized price feeds, initiate margin calls centrally, provide liquidity centrally, centrally determine interest rates, as well as centrally administer updates and platform developments.
Examples – Dharma.
Degree 2 DeFi: These level 2 DeFi products are non-custodial but have one additional decentralized component from the list while rest are centrally operated.
Examples – Expo, Nuo, ETHLend.
Degree 3 DeFi: Degree 3 DeFi products are also non-custodial and have permissionless initiation of margin calls and provision of margin call liquidity, while the rest are centrally administered.
Examples – MakerDAO, Compound.
Degree 4 DeFi: What’s different in these types of DeFi products are in addition to being non-custodial, having permissionless margin calls and provision of margin call liquidity, its price feeds are decentralized, while the rest two are centralized.
Examples – dYdX, Fulcrum.
Degree 5 DeFi: Here, the interest rate determination is decentralized along with the first three components in Degree 4 DeFi, but the control for the platform developments and updates is centralized.
Examples – bZx.
Degree 6 DeFi: In the last category every component of DeFi should be decentralized. But as of now no DeFi protocol is completely decentralized.
Similarly, for Stablecoins also, except for a few like DAI, not all stablecoins are decentralized. They are simply tokens that represent fiat currency deposits held in a bank somewhere. That’s why you can tokenize your asset and move around the blockchain, but the need to redeem and manage the money physically exists.
Until the law completely adapts to DeFi services, there will always be some form of centralization. For example, take the case of buying a property on the blockchain. Though you can tokenize the deed, the law and the court of that country should recognize that.
Do DeFi’s carry risk?
With any high return product, there are always risks. DeFi’s are no exception.
We must all treat Cryptocurrency Assets as valuable because they are! We would not leave gold, diamonds, or even cash lying around, so why would we not secure our Crypto Assets as well? Always, always keep your private keys and passwords stored in a safe place! Perhaps an asset storage hardware device and two-factor authorization?
Anyone or group that deals who deal with financial products and keeps records thereof require specialized knowledge. With this in mind, we must realize that there are definitely risks involved.
With the stakes high naturally, hackers are always on the prowl to try to get into and steal from any cryptocurrency wallet or financial product. Remember the hack of the DAO in 2016? The hacker managed to crack some coding vulnerability and transfer 1/3rd of the DAO funds to another account. This hack forced the Ethereum Blockchain to hard-fork to be able to restore those funds. The Dapp and Smart Contract security have since become much more secure. But to take for granted, this will stop hackers ultimately would be a mistake, as they will always continue to try.
Hopefully, soon, we will see DeFi become the “New Norm” in finance with a wider scope of users than the traditional finance enjoys. Would that be a bad thing?
Should you want to read more about this technology and delve deeper into it, please go to https://blockgeeks.com/guides/demystifying-defi-ultimate-guide. – credit to the same