The DeFi Ecosystem
In the world of Ethereum, every line of code represents a money lego. Every product is a combination of legos and every developer is free to design their own, play with each others pieces, or connect combinations to create new and more robust features.
Decentralized Finance is an ecosystem built on these money legos beckoning millions of developers to share infrastructure for security, build bridges for interoperability, and add pieces for new functionality.
As the number of pieces in the lego bin grows, the number of possible combinations (decentralized financial products) multiplies exponentially.
Before we dive into the universe of DeFi possibilities, let’s take a look at the core pieces that comprise the ecosystem.
Asset Management: Crypto wallets used to store/transfer funds and access decentralized applications (dApps)
Decentralized Exchanges: DEXs aggregate liquidity pools to enable P2P trading of cryptocurrencies and derivatives without centralized intermediaries
Derivatives: Protocols that issue leverage and derivative products for a variety of underlying assets (forex, crypto, equities, commodities, indices, etc.)
Lending / Borrowing: Platforms that enable anyone with an Ethereum address to lend and borrow P2P
Marketplaces: P2P marketplaces for digital assets such as ERC721 collectibles
Stablecoins: Cryptocurrencies designed to minimize volatility by pegging price to external assets such as USD or gold
Insurance Platforms: Protocols designed to hedge risk of smart contract code and price volatility
Prediction Markets: Platforms for forecasting and betting on the outcomes of future events
KYC & Identity: Blockchain solutions for managing identity data and exchange
Infrastructure: Crypto primitives and blockchain building blocks for Web3 developers
Now that we’re acquainted with the pieces, let’s combine them to walk through a decentralized adaptation of one of the world’s most common financial services: lending and borrowing.
Lending and Borrowing in DeFi using Aave
The Aave protocol combines multiple DeFi money legos like user wallets, ERC20 tokens, and custom smart contracts to provide a market for lenders and borrowers to transact trustlessly.
Similar to other lending protocols like Compound, Aave users can simply connect their Ethereum wallet and click on Deposit or Borrow to view a list of supported assets and current interest rates. In the spirit of DeFi, Aave added a few new legos to provide additional features and products for users and developers alike — notably uncollateralized aka “flash loans” and rate switching.
Aave allows users to access virtually free capital by enabling smart contracts to borrow assets, execute trades, and repay loans within the same Ethereum transaction. This single feature opens the flood gates for a variety of new and extremely lucrative trading strategies that are now made profitable through low cost capital.
I cover these strategies as well as a few notoriously profitable trades in my post, Yield Hacking in Defi.
Hope you enjoyed and thanks for reading!
