Welcome to the premiere of PYMNTS ‘eight-part Decentralized Finance (DeFi) series.
Over the next few days, we’ll take a look at every part of DeFi – the most important, hottest, most rewarding, and riskiest part of the blockchain revolution.
By the end, you will know what DeFi is, how it works, and the risks and rewards of investing in it.
So what is Challenge ? Well, first of all, DeFi is hot. This is the most promising – and problematic – part of FinTech cryptocurrency.
There is over $ 107.6 billion stuck in DeFi. As of January 2020, that number was $ 0.67 billion.
More prosaically, DeFi is a peer-to-peer (P2P) financial service that has few or no middlemen.
In some ways, it is the purest form of blockchain. Blockchain technology began with the Bitcoin White Paper written by anonymous Satoshi Nakamoto. Its first line describes bitcoin as a “purely peer-to-peer version of electronic money. [that] would allow online payments to be sent directly from one party to another without going through a financial institution.
In other words, no banker, no credit card issuer, no payment processor, really no financial intermediary. At least in theory.
DeFi encompasses almost anything you can do in a bank or brokerage with old regular (non-crypto) currency: send it or receive it, borrow it or lend it and keep it in interest-bearing accounts. You can trade crypto assets, buy and sell derivatives like options and futures, and hold them assuming their value increases.
The latter can be a good bet – if you choose well. Bitcoin (BTC) only rose 94% in 2021, but ether (ETH) is up 522%. However, Solana (SOL) is up by almost 13,000% and Polygon (MATIC) by around 11,700%. And they are not close to the biggest winners.
The code is law
DeFi apps work using smart contracts, which are self-executing contracts. This means that there is no intermediary or third party to decide whether a contract has been executed. When a smart contract is created, the parties read the terms and the cryptocurrency needed for payment is locked into it. There is no withdrawal, no change in terms, and no one to declare it unfair. There is also no one to fix a poorly drafted smart contract.
The industry term is “code rules,” which is why DeFi is the ultimate platform for Warning – that the buyer is wary.
Smart contracts were invented on ethereum, the second largest cryptocurrency by market cap, and the vast majority of DeFi platforms run on it. The same goes for most non-fungible tokens (NFTs) which is why Ethereum is overloaded, barely able to handle all DeFi transactions made on it. This is also why smart contract platform tokens designed to fix it (Polygon) or replace it (Solana) have grown so rapidly.
With DeFi, according to the Ethereum Foundation, “the markets are always open, and there is no centralized authority that can block payments or deny you access to anything.”
There’s also not much control, which is a problem as DeFi platforms are particularly susceptible to hackers. In August, a hacker stole $ 612 million in funds from the DeFi blockchain Poly network (not related to Polygon) – the biggest cryptocurrency hack ever. The fact that the hacker sent everything back a few days later made it an outlier. Cream Finance was unlucky, losing $ 150 million in two separate attacks.
While all DeFi protocols are created by centralized groups, virtually all of them seek to become Decentralized Autonomous Organizations (DAO).
DAOs (in theory) have no centralized governance, with all decisions – whether to change an interest rate or implement a code update – made by token holders. It also makes the implementation of legal requirements such as anti-money laundering (AML) rules problematic.
Best DeFi Apps
Decentralized exchanges (DEX): Same as any other crypto exchange except that no company operates it and cryptocurrency transactions are completely P2P.
Borrowing / lending platforms: Lenders can lock in cryptocurrency on these platforms to earn interest, while users can borrow stablecoins by putting up collateral – 150% of the amount borrowed is common to account for price volatility. The goal is to withdraw funds from crypto holdings without selling your bitcoin (or whatever) which you think will continue to rise in value.
Encapsulated crypto-currencies: By wrapping bitcoin, you lock it into a platform that gives a usable token on ethereum. You get the bitcoins by turning them over. There are many variations of the tokens that can be wrapped.
Stablecoins: While most stablecoins maintain their value by holding an individual basket of fiat currency, algorithmic stablecoins can do so by minting or automatically buying and burning coins to keep the value at $ 1.
Yield agriculture: Lending cryptocurrency to a DeFi protocol that places it in a loan pool in order to earn interest. These can get very complex.
Next step: What are the best DeFi platforms?
Projects we’ll be looking at include Curve, Compound, Sushi, and PancakeSwap. And if those names don’t sound too serious, know that there are billions of dollars locked away in this list.