DeFi 101: A Guide for Investors in Crypto
Did you know that there's a growing movement in the crypto space that allows you to borrow, lend, or get insurance within minutes in a decentralized way?
DeFi (or decentralized finance) has been one of the hottest topics in the cryptocurrency industry for some years now.
And it's no surprise. DeFi constitutes a powerful concept that fulfills and perhaps even surpasses the initial goal of Bitcoin. Namely, by creating a decentralized peer-to-peer (P2P) payment system.
With a total market cap of $82.01 billion, the decentralized finance industry has been growing rapidly. Since January 1, 2018, the DeFi market has surged by over 2,160%.
But what is DeFi, and how could it have grown so fast?
These questions are important to investors in crypto, as many of the coins listed on AAX derive much of their value and utility from developments in this space.
What is DeFi?
DeFi refers to a movement that includes a collection of financial services (e.g. trading, lending, borrowing, payments). These services utilize decentralized infrastructure to operate in the form of a blockchain network and smart contracts.
The traditional payment industry is centralized by nature, which often leads to inefficient products and services, and it requires a degree of trust in such central institutions that are arguably not justified.
Think about it: to apply for a loan, you have to visit your bank and provide several documents. Then you have to wait weeks until the financial institution reviews your papers and decides on the fate of your loan application.
On the other hand, DeFi provides global access to anyone in the world, with a decentralized alternative for traditional financial services such as trading, insurance, savings, and loans.
To access these services, you don't have to submit documents and wait days for the service provider to review your loan application.
Instead, you only need a smartphone or a desktop device with an active internet connection. Simply open the app, specify the funds you seek to borrow, and the service will automatically guide and pair you with a lender who loans you money.
What Are the Core Features of DeFi dApps?
We've created a table for you to illustrate the main features of DeFi decentralized applications (dApps) as well as the main differences with traditional financial services.
|Core Feature||DeFi dApps||Traditional financial services|
|Management||Unlike traditional financial services, DeFi dApps are not managed or controlled by anyone. Instead, the applications use smart contracts and blockchain tech to run without (or with minimal) human intervention.||Every traditional financial service is managed and screened by an organization or an institution (e.g., a bank). Therefore, these services are centralized by nature.|
|Access||Global. Anyone with a capable device and an active internet connection can access and use DeFi dApps.||Guided by local regulations, user access is determined by the service provider. Some financial services (such as loans) are only available nationally or regionally. Additionally, it's important to remember that there are still around 2 billion unbanked people in the world.|
|Level of transparency||High. DeFi dApps are open-source with the code published on the blockchain for anyone to audit. All transaction activity is also available for anyone to check.||Low. Unless regulations require otherwise, traditional providers are generally reluctant to share information about their products and services with the public.|
|Level of interoperability||High. Most DeFi dApps are built in a way to combine other products (e.g., stablecoins, decentralized exchanges, loan services).||Low. While some service providers combine their services with their other products, they are not integrated with the financial products of other organizations.|
|User experience||Flexible. If you don't like the interface of a DeFi app, you can use a third-party platform or even create your own.||Standard. You have to use the interface the service provider originally built for the app.|
What services do DeFi dApps provide?
In this section, we'll explore the most common products and services available in the DeFi space. With the emerging number of new projects that have added themselves to the already extensive list of dApps out there, there is a solution for every type of crypto enthusiast, investor, and trader.
Lending and borrowing
Currently, borrowing and lending products are the hottest and most common types of applications used in the DeFi market.
The two largest DeFi dApps (by market cap) – Aave and Maker – have a combined market share of 31%.
These platforms allow people to either borrow funds by using their cryptocurrency as collateral or to earn interest by lending their digital assets to other users.
Top platforms like Aave and Maker feature other products within their dApps (e.g., stablecoins). They also offer access to other DeFi services.
Examples of lending and borrowing DeFi products:
- Aave: currently the largest Ethereum-based DeFi protocol that enables users to act simultaneously as a lender and a borrower. Read our guide to learn more on Aave.
- MakerDAO: a decentralized credit platform
- Compound Finance: an algorithmic money market protocol. Here’s our DeFi guide on Compound.
- InstadApp: an intuitive interface on top of MakerDAO helping users that lack the necessary technical and financial experience.
Decentralized exchanges (DEXes)
Decentralized exchanges or DEXs aim to emulate the services of centralized exchanges by using smart contracts to operate without managing user funds.
As smart contracts automatically match buyers with sellers, the benefit of decentralized exchanges is that users are able to eliminate intermediaries.
However, the downside of these DeFi services is their limited popularity as most crypto users are utilizing centralized services (that have better interfaces, faster transaction speeds, and higher liquidity) to trade their assets.
Examples of decentralized exchanges:
- Bancor: a decentralized liquidity platform. Read more about Bancor in our DeFi guide.
- Atomex: a multi-currency wallet featuring a built-in atomic swap exchange.
- Serum: an on-chain DEX based on Solana blockchain that enables real-time trades between users at low cost. Read our guide for more information on Serum.
- IDEX: a DEX featuring real-time token exchange
- Uniswap: a decentralized Ethereum-based lending platform that offers liquidity pools for token swaps. Here's addditional information on AAX regarding Uniswap.
When someone uses an insurance service, the provider guarantees compensation for different events (such as death, loss, damage, and illness) to the client in exchange for payment of a premium.
In the DeFi space, the service host is often the dApp's community itself, featuring a decentralized protocol to provide blockchain-powered insurance products.
For example, Etherisc – an insurance platform built on Ethereum – features multiple decentralized, community-built insurance products (such as hurricane protection and flight delay insurance) that users can purchase.
Examples of DeFi insurance services:
- Etherisc: a decentralized insurance protocol featuring community-built risk transfer solutions
- Nexus Mutual: a service for users to secure risk and bugs in smart contract codes
- VouchForMe: a blockchain service where users can save money by sharing risk
Blockchain networks utilizing the Proof-of-Stake (PoS) consensus algorithm require validators to stake a part of their cryptocurrency funds to create, propose, and vote on blocks in the network.
In exchange for maintaining the network, PoS validators are rewarded for staking their digital assets.
To support this consensus algorithm and secure a passive income (similar to savings accounts with banks), developers have created DeFi dApps where they can use decentralized products like staking pools and Staking-as-a-Service solutions.
Examples of DeFi staking apps:
- StakeWithUs: a Staking-as-a-Service for PoS protocols
- Mythos: a validator service for Cosmos and Loom networks
- Dokia Capital: a professional institutional staking service
Decentralized payment services are usually a good choice for the unbanked, crypto enthusiasts, and even financial institutions.
That is because the unbanked often do not have access to basic financial services, such as a savings account, loans, and more. Decentralized financial apps equip the unbanked with the appropriate tools to manage their own finances, whether it relates to sending money digitally or opening a checking account.
DeFi apps are also interesting for retail and institutional investors, for similar reasons that may be appealing to the unbanked. They enable transactions to be conducted at lightning speed, in a quick efficient manner with minimal fees. DeFi apps also eliminate the need for a third-person party and transactions are made in real-time.
Nowadays, as transactions are increasingly conducted digitally and the world is seeing a transition towards a cashless society, many DeFi payment services are available for crypto enthusiasts to use.
Examples of DeFi payment services include:
- Lightning Network: a network built on top of Bitcoin featuring smart contracts as well as low-cost and fast off-chain payments. Find out more about Lightning Network in our DeFi guide.
- Request Network: a decentralized network that allows users to request, validate, and execute payments.
- Strike: a financial services payment that recently partnered with Twitter to enable Bitcoin payments.
- Whisp: a decentralized payroll solution featuring crypto payments.
What are the top blockchain platforms for DeFi?
DeFi products need a blockchain to operate. Most of them use platforms like Ethereum and EOS that support both smart contracts and dApps.
However, Bitcoin is also a popular choice for DeFi developers as the Lightning Network – the cryptocurrency's Layer 2 scaling solution that supports fast and low-cost off-chain transactions – allows for dApps and smart contracts to be created and operated on the platform.
- Ethereum: The blockchain that features the second-largest cryptocurrency (ETH), as well as many dApps and millions of smart contracts, is the most popular platform for DeFi with approximately 200 projects built on top of the Ethereum network.
- Bitcoin: With the implementation of the Lightning Network, Bitcoin has become the second-largest DeFi blockchain, supporting 24 decentralized finance apps.
- EOS: Smart contract platform EOS, Ethereum’s main competitor, comes behind Bitcoin as the third most popular blockchain that hosts 21 DeFi apps.
DEX vs CEX: What is the difference?
Although the whole crypto industry seems to be shifting more towards a decentralized model, there are still several centralized exchanges within the crypto space.
Are decentralized exchanges better than centralized ones then?
That depends on what your specific needs as an investor consists of.
As much as some investors value the autonomy and control that comes with a decentralized platform, others would much rather have another entity managing their financial accounts. In this way, they can rest assured that their funds are professionally managed. This also eliminates the possibility of forgetting one's private keys, which serve to unlock digital wallets on which crypto funds are stored.
This video offers a comprehensive view of the differences between decentralized exchanges and centralized exchanges (CEXes): CEX vs DEX | Is DeFi taking over?
Whether you choose to participate in DeFi or to invest in it, AAX offers a comprehensive hub of DeFi projects for crypto enthusiasts to leverage. This guide on investing in DeFi on AAX will teach you more on how to proceed with your investments.
DeFi: Crypto is more than just payments and 'hodling'
With a surging market share, DeFi grants users global access traditional financial products without intermediaries and the supervision of a centralized authority (e.g., the service provider).
Therefore, DeFi is the real-life proof that cryptocurrency is more than just a digital asset that is exclusively used for facilitating decentralized (P2P) payments or for speculative trading.
And with the rise of DeFi, blockchain technology, and cryptocurrencies seem to be honing in on fulfilling the initial goals articulated by Satoshi Nakamoto – the creator of Bitcoin – which is to foster financial inclusivity, freedom and true ownership, for everyone.
Want to learn more about the various coins or which blockchain platforms are implicated in the rise of DeFi? Take a look at the various guides for coins on AAX Trends.
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