Summary of Previous Chapter
In Chapter One, I made an outline between traditional finance and decentralized finance. I also described 3 key areas where Defi Dapps are trying to make a difference.
If you want to read more about my Review of Chapter One, here's the link.
Chapter Two: What is Decentralized Finance?
Decentralized Finance or Defi is the movement that allows users to utilize financial services such as borrowing, lending, and trading without the need to rely on the centralized entities.
Defi is a set of products and services that replaces traditional financial institutions which are accessed through decentralized applications or Dapps.
To make Defi Dapps work, collaterals must be locked into smart contracts. The aggregate collateral locked in Defi Dapps is called Total Value Locked (TVL).
3 types of Defi (in terms of decentralization)
1. Centralized - This Defi is characterized as custodial, uses centralized price feeds, centrally determined interest rates and centrally provided liquidity.
Popular examples include BlockFi, Nexo and Celcius
2. Semi-decentralized - Projects that has one or more of the characteristics of the first but not all.
Examples include Compound, MakerDAO, dYdX, bZx
3. Fully Decentralized - No Defi protocol is fully decentralized yet since it requires every component to be decentralized.
7 Defi Types
The book provides for 8 Defi types but I think, what is available in Defi landscape is only 7. The book identifies stable coins as a type of Defi but I think it is not. It is just an important element of Defi but not a Defi Dapps or protocols in itself.
Stable coins were created to mitigate the volatility of crypto assets and are usually pegged to other stable assets like the US Dollar.
While these coins are not Defi applications, they are crucial in the Defi ecosystem as stable store of value.
1. Lending and Borrowing
Traditional finance requires the borrower to have a good credit score and sufficient collateral. When borrowing in Defi, one does not need a credit score, all you need to do is make your digital assets the collateral for the loan. The user can also earn an interest by contributing to the lending pools.
Decentralize exchanges allow users to exchange crypto currencies without giving up custody of their coins.
A derivative is a contract whose value is derived from another underlying asset such as stocks, commodities, currencies, indexes, bonds or interest rates.
Defi Dapps are starting to build decentralized derivative markets.
4. Fund management
It is the process of overseeing your assets and managing its cash flow to generate a return on your investments. Some Defi projects have started to allow passive fund management to take place. The transparent feature of Defi projects make it easy to track the funds and have the project audited.
The idea here is to pool resources together and have this invested in a Defi Dapp. The interest is awarded to a random winner coming from the investors of the pooled fund.
The decentralized and trustless transfer of value between two parties. But more innovations are being development on payment in the Defi ecosystem.
Insurance is a risk management strategy where a person receives financial protection against losses arising from unfortunate events. This is another area where Defi applications are being developed.
The 7 Defi Apps are traditional financial products only difference is blockchain technology is being used. Of the 7, I am very much familiar with Lending and Borrowing because I have an account in Nexo which allows me earn interest by lending my money. If you haven't heard about Nexo, just visit their website. What attracted me to deposit my crypto here is their daily compounding interest.
With respect to decentralized exchange, I have heard a couple of them, the most famous of which is Uniswap. I have used another type of exchange where I converted my Bitcoin Cash to Zec at very low fee. Try this secret crypto exchange hosted in Read.cash.
Lottery seems very promising, it could be further tweak where everyone could have a share of the profit in proportion to their investment instead of a winner take all feature.
What is not mentioned here are the concepts of yield farming, staking and liquidity provision, it is interesting to see how the writers will classify these other concepts.
Are there other types of Defi Dapps missed by the writers, please comment below.
If you like me to continue writing this kind of blog, please hit like and subscribe. Your support would inspire me to write more content like this in the future.