Why Decentralized Finance (DeFi) is the Future of Cryptoassets
Decentralized finance (DeFi) is hailed by experts as the key driver to blockchain adoption today.
What is DeFi and how will it enable the future of finance on the blockchain?
What is Decentralized Finance (DeFi)?
DeFi is a suite of financial products and services built on the blockchain, most notably Ethereum. Unlike traditional institutions, DeFi encourages interoperability among providers through open-source protocols and coexisting tools. It’s not out of place to see companies in DeFi integrating services with others even if they’re operating in the same vertical.
This creates an open finance landscape where participants enjoy cutting-edge financial services with improved ownership of their assets thanks to decentralization. The unbanked and underbanked gain the most from DeFi since they’re no longer bound to expensive, lengthy, and tedious processes of traditional financial institutions.
The DeFi market recently hit the $1 billion mark. Analysts expect the industry to grow further as blockchain adoption increases and more individuals are allured by the exciting use cases of DeFi.
Popular Applications of DeFi Today
1. Crypto Lending
Crypto lending is perhaps the most popular application of DeFi today. Peer-to-peer loans are not a new concept. However, the blockchain has taken it to a whole new level.
Providers like Maker, Dharma, and Compound are revolutionizing the lending space with instant crypto loans that don’t come with the lengthy applications and hefty interest rates of traditional loans. Lenders also benefit, as crypto loans offer some of the highest APR returns in the market — some as high as 10%.
Several advantages of crypto lending in DeFi include:
- Instant loans backed by a wide variety of cryptoassets
- Easy borrowing, lending, and repayments with intuitive digital platforms and tools that integrate with each other
- Minimal credit checks, which make it attractive for the unbanked and underbanked
- Little to no transaction costs
With the industry’s liquidity pool growing 10 times faster than JPMorgan’s loan balances in 2019, it won’t be a surprise if crypto lending becomes the application that propels DeFi into the mainstream.
2. Collateralized Debt Position
The collateralized debt position (CDP) from MakerDAO is one of DeFi’s most popular products. It allows users to lock cryptoassets as collateral to generate Dai, a stablecoin based on Ethereum’s ERC-20 protocol. The generated Dai can be used for anything, including buying more crypto or trading it for fiat.
Users can generate up to two-thirds of the value of their collateral. However, this incurs debt in the user’s CDP account. This debt can be repaid in full or on a pro-rata basis to recoup the collateral. Failing to do so will result in the CDP being liquidated. Any collateral leftover from repaying the debt is then returned to the user with a minor liquidation fee.
3. Token Issuance Platforms
Token issuance platforms take the pain of creating blockchain tokens away from companies. They provide the expertise, tools, and resources needed to deploy tokens along with other services like legal advice — think of them as all-in-one consultants. While the days of million-dollar ICOs are over, tokens are still in-demand for various applications including tokenized securities and private blockchains.
Like other DeFi services, issuance platforms work hand-in-hand with financial bodies, legal firms, and even end-users to ease the token creation process for their clients. As more companies experiment with their own private blockchains, issuance platforms will rise in popularity to fill the technical gap of decentralized technologies in organizations.
4. Banking the Unbanked and Underbanked
Individuals worldwide send billions of dollars to their friends and families every day, but remittances are not as efficient as they should be. International transfer fees are expensive when transaction fees and exchange rates are factored in. A cross-border transfer could cost up to $50, which is not ideal for individuals with medium to low incomes.
DeFi solves this problem by processing transactions on the blockchain. Not only does this cost a fraction of standard remittance fees, but it also sends money faster than standard financial networks. With DeFi, an employee in Europe can send funds to his family in Asia for less than a dollar and have the money received in less than 30 seconds.
This, combined with other DeFi products like crypto loans, make financial services possible for the unbanked and underbanked without costing a fortune. This will spur spending in these communities, which will benefit both the growth of the blockchain industry and the global economy.
5. Decentralized Exchanges
Previously, investors had to rely on centralized exchanges to buy and trade cryptoassets. For heavy traders, the accumulation of exchange fees was a pain as it ate into profits. There are also serious security risks in centralized exchanges as shown in numerous high-profile breaches in the past.
Decentralized exchanges (DEX) were built in response to this problem. DEXs are fully peer-to-peer, which eliminates unnecessary transaction fees. Investors and traders feel safer using DEXs as they own their assets and they’re not stored in exchange wallets, reducing the risk of stolen funds.
The top DEXs in terms of usage and liquidity today are:
- IDEX
- Bisq
- Bancor
- Uniswap
- Kyber Network
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