DeFi Empowerment is Not Going Away — Here’s What to Watch
Decentralized Finance, or DeFi, refers to the growing field of cryptocurrency and blockchain technology designed to deliver financial services without relying on intermediaries.
Diverging from traditional financial services that retain some control over transactions through entities such as brokerages or banks, DeFi applications have no centralized administrator. They are composed of individual protocols, or contracts, that eliminate the need for intermediaries and are available to anyone regardless of user background or country location.
DeFi, which involves embracing peer-to-peer transactions over legacy systems, is distinct from Open Finance, or OpFi, which refers to the movement by companies to use APIs and blockchain technology to increase connectivity and transparency, but by using existing systems. DeFi allows anyone to freely interact with the crypto assets they own. Here are the most well-known DeFi projects that have emerged in recent years:
Maker issues and holds Dai, “a decentralized, unbiased, collateral-backed cryptocurrency,” which it dubs “the world’s first unbiased currency,” with a value linked to the US dollar with ETH as collateral. The goal is to ease restrictions, such as limits on exchange rates or the inability to open a bank account, for those who have no financial, political, or physical access to the US dollar. Maker generates Dai to provide access to US dollars by generating Dai, which can be exchanged online.
Compound acts as a so-called cryptocurrency bank. In traditional finance, the bank acts as an intermediary between the lender and the borrower by facilitating deposits and loans. By its nature, this traditional model carries bankruptcy risk and as well as risks arising from a lack of transparency, as the intended purpose of the deposited funds is unknown. Compound reduces bankruptcy risk by building its service on a protocol, a series of smart contracts, and presenting a rate according to supply and demand to both parties. The deposited assets are managed on the contract with the transparency of the Ethereum blockchain, which can store the monetary value as a database.
Uniswap is a decentralized exchange protocol built on Ethereum. It is a fully automated liquidity pool that allows anyone to participate, provide liquidity, and trade between Ethereum (ETH) and ERC-20 tokens. The protocol eliminates the need for order books typically seen on centralized exchanges and reduces the risk of market manipulation. Anyone can become a liquidity provider by depositing the crypto assets they own.
What Is A DEX (Decentralized Exchange)
DEX plays an important role in the DeFi ecosystem. Most cryptocurrency exchanges in the blockchain world are centralized in nature. Only a few exchanges, such as Uniswap, are decentralized. These are known as DEX or Decentralized Exchange.
But how are decentralized exchanges different from centralized ones, and what purpose do they serve? Well, the answer lies in blockchain and cryptocurrency’s core philosophy.
When cryptocurrency was first introduced, it gave people true independence and autonomy over their money. With the emergence of DeFi, the vision expanded to people managing their own money and performing financial tasks such as payments, lending, borrowing, etc., without any banks, brokers, or intermediaries.
Decentralized exchanges, in essence, accomplish this. They are peer-to-peer exchanges where trades happen directly between crypto investors instead of going through intermediaries or other authorities.
Due to this, although most exchanges are centralized in nature, DEX has been booming since 2020. According to a Bloomberg report in 2020, amidst DEXs becoming the hottest trading niche, Uniswap became the most sought-after Ethereum based DEX.
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This boom shows no signs of stopping and is continuing even in 2022. Currently, Uniswap has all-time 93 million trades with a trading volume of over $902 billion and has a count of over 1.5 million all-time traders. This is just one DEX. There are numerous others, such as PancakeSwap and SushiSwap, which would have more such astronomical numbers.
These numbers show how DEXs are gaining immense popularity amongst blockchain and crypto enthusiasts. So how does it all work?
How Do DEXs Like Uniswap Work?
Uniswap or other DEXs function with the help of smart contracts. These smart contracts automatically calculate the value of a cryptocurrency with the help of built-in algorithms. Furthermore, in a decentralized exchange, liquidity pools are leveraged to facilitate exchanges.
These liquidity pools are where investors can lock their funds for any asset of their choice to earn trading fee income.
Another interesting aspect is that decentralized exchanges are cryptocurrency exclusive. This means that only crypto-to-crypto pairs are available, and one cannot perform trades using fiat currency. However, numerous credible stablecoins are available on the platform that essentially have the same value as fiat currencies that backs the stablecoins. So people can invest in them as well.
A few other examples of DEXs are HoneySwap, SpookySwap, Curve Finance, etc.
Related Stories: A Beginner’s Guide to DEX Aggregators
On the other hand, centralized exchanges are pretty different where authorities officiate all the trades and transactions. The transactions are handled with order books, and the prices are calculated instantaneously based on the buy and sell orders.
Furthermore, fiat currency is available on centralized exchanges, and one can leverage it to buy cryptocurrencies and even exchange crypto for fiat currencies.
Due to the way decentralized exchanges work, they have numerous advantages for the users. Some of them are as follows:
Benefits Of Decentralized Exchanges
Decentralized exchanges are closer to the core philosophy of blockchain and cryptocurrency. This means there are numerous advantages for users who believe in that philosophy. Some of these are as follows:
On decentralized exchanges, one doesn’t have to share information such as social security numbers, ID, etc., and can remain anonymous. This isn’t the case with centralized exchanges, which ask for identity verification and KYC/AML. This is due to the regulation standards that they have to abide by.
Reduced Risk Of Hacking
Unlike a centralized exchange or institution, the funds here are stored on the blockchain and in users’ private wallets. Despite the risk of protocol failure and hacking may still exist, protocols such as Uniswap that are thoroughly vetted by third parties make the risk of getting hacked much lower. It also reduces the risk of counterparty risks where one of the parties involved will default on their payments.
Reduced Risk Of Market Manipulation
Centralized exchanges are susceptible to market manipulations, and in fact, there have been assertions of markets being manipulated in the past. This is possible because only peer-to-peer trading is allowed, and hence fake trading or wash trading can be prevented.
More Variety And Options
Decentralized exchanges have a wide variety of crypto assets which includes numerous altcoins, stablecoins, etc. Right from the most popular cryptocurrencies to new ones, all of these are available on DEXs such as Uniswap.
This is because anyone can create liquidity pools for assets by minting themselves, and hence all sorts of assets are available.
Open Source Code
Most DEXs are built using open-source code. This enables anyone and everyone to look into how the system works, accomplishing complete transparency. Furthermore, it also fosters innovation because anyone else can use these codes to create other projects. For instance, Uniswap has an open-source code, and other swap platforms such as PancakeSwap and SushiSwap come from the same code as Uniswap.
Decentralized exchanges are more accessible to people compared to centralized exchanges. This is because all one needs is a phone and an internet connection. As a result, numerous developing countries can leverage these platforms to invest, trade, and earn more profits than their traditional system.
This is because their countries might not have the necessary infrastructure for performing financial transactions. Even if they do have, they wouldn’t be accessible to all, or the amount of interest on loans and deposits might not be as good as those provided on numerous DEXs.
In general, decentralized exchanges are gaining more popularity because they are close to the core blockchain philosophy. In the coming years, the decentralized finance space will expand further by providing more customized tasks and features that can empower platforms to become a one-stop shop for all things finance.
At GMO-Z.com Trust, we continue to explore possibilities in the DeFi space. For users looking for decentralized exchanges to trade GYEN, Uniswap V2 and V3 are both ready for you now. Learn more about GYEN and our ecosystem at our website.
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