THE FUTURE OF DeFi

You must have questions in mind seeing the topic. “The future of DeFi” Yes! I’m here to guide you through all you need to know about DeFI. If you are familiar with the Crypto Space, you would know that Cryptocurrency has taken a huge growth being a digital/virtual currency. 

Cryptocurrency is what I would call a digital or virtual currency that is secured by cryptography. This makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology. 

There are over 12,000 cryptocurrencies in existence today and over 20,000 different types of markets. Examples of some are; Bitcoin, Ethereum, Litecoin...e.t.c which are denoted BTC, ETH, and LTC respectively.

WHAT IS DECENTRALIZATION/DECENTRALIZED NETWORKS?

DECENTRALIZATION is the movement of departments of a large organization away from a single administrative center to other locations. Decentralized networks are organized in a much more distributed fashion. Each node within the network functions as a separate authority with independent decision-making power regarding how it interacts with other systems. 

These networks also distribute processing power and workload functions among connected servers. The opposite of Decentralization is Centralisation or centralization which is the process by which the activities of an organization, particularly those regarding planning and decision-making, framing strategy and policies become concentrated within a particular geographical location group. 

In simpler terms, the concentration of control of an activity or organization under a single/central authority. Decentralization is just the Antonym for Centralization. The traditional finance market is centralized. The centralization of finance underpins the global economy.

BLOCKCHAIN - A blockchain is an immutable time-stamped series record of data that is distributed and managed by a cluster of computers.

Now I have made these terms above known, just so that when discussing DeFi, no one is lost trying to find out the meaning of certain crypto-related terms in DeFi. I have also provided direct links to the definitions if you find my explanations not so explanatory. And that’s because we are heading for the business of the day, which is DeFi.

NOW, what is DeFi?

DeFi is an abbreviation of the phrase ‘Decentralized Finance’ which generally refers to the digital assets, financial smart contracts, protocols, and decentralized applications (DApps) built on any network platform. In simpler terms, it's a financial software built on the blockchain that can be pieced together. i.e can be combined, modified, and integrated according to your needs.

What is a smart contract?

A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network.

Relationship between Decentralized Applications (DApps) and Smart Contract.

Description

A decentralized application is a computer application that runs on a distributed computing system. Decentralized Applications or DApps have been popularized by distributed ledger technologies such as the Ethereum Blockchain, where DApps are often referred to as smart contracts.

What is DeFi Offering?

DeFi is offering you control of your own assets. Many new-age banks and fintech firms promise to provide more control to the users, but the reality is, you are still trusting in them to manage your funds. There’s a saying in the blockchain space: “Don’t trust, verify.” Because with a blockchain network, you as an individual can verify any and every transaction that occurs on the blockchain. 

The objective of DeFi is to give you full control of your assets, and it can. This is because of decentralization and blockchain technology. Also, many developers of financial apps are adopting open-source protocols for trading through decentralized exchanges. 

The fact that all protocols are open-source allows anyone to build new financial products on top of them. Developers across the globe can collaborate with each other to create new products leading to faster innovation and a secure network. Seems like we are already having a taste of what future DeFi is. 

Anyone can store, trade, and invest their assets in blockchain securely and earn a much higher return than from the traditional financial system. 

Since there’s no intermediaries handling your asset, you have complete control over your investments. Take it like this, if we have to take our FIAT currency to the bank, we are following a centralized network because our assets and money aren’t totally controlled by us but the bank standing as a central network. 

In Decentralization, you get to control every of your digital assets/virtual currencies yourself. 

The DeFi Ecosystem and Its Products

The various products involved in DeFi are also collectively referred to as open finance since it’s an ecosystem where blockchains, digital assets, and open protocols are integrated with conventional financial structures.

1. Open Lending Protocols

As the name implies, this is a digital money lending platform built on a blockchain. Open Lending Protocols have probably become the most popular among other open finance sectors in recent years. Thanks to the recent extensive use of DAI (Stablecoin), other peer-to-peer protocols such as Dharma, and liquidity pool designs such as Compound Finance. 

Just like a bank, users deposit their money and when someone else borrows the digital assets they earn interests. However, instead of intermediaries, the smart contracts dictate the loan terms, connect lenders and borrowers, and are in charge of distributing the interest. Due to the inherent transparency of the blockchain and no middleman, the lender earns higher returns and more clearly understands the risks. 

The Open Lending Protocol is strictly based on a public blockchain like Ethereum and thanks to the importance of its capability to lend digital assets which can be widely adopted globally. It offers several advantages over the traditional lending/crediting services – 

• Integration with digital asset lending or borrowing.

• Collateralization of digital assets in case of defaulting on the loan.

• Instantaneous settlement of transactions and new secured lending methods.

• Standardization and interoperability which can also reduce costs with automation.

• No credit checks, meaning broader access to people that cannot tap into traditional services.

There are quite a number of lending protocols. DeFi lending protocols are ranked from Degree 0 (CeFi) to Degree 6 DeFi.

Degrees

Degree 0 DeFi Aka CeFi - Custodial in nature, use centralized price feeds, and initiate margin calls, provide liquidity for their margin calls, and centrally determine interest rates all centrally. Examples are BlockFi, SALT, Celsius, Binance, Nexo, e.t.c.

Degree 1 DeFi - Non-custodial but use centralized price feeds, initiate margin calls centrally, provide liquidity centrally, centrally determine interest rates, as well as centrally administer updates and platform developments. Example - Dharma. 

Degree 2 DeFi - Non-custodial but have one additional decentralized component from the list while rest are centrally operated. Examples are Expo, Nuo, ETHLend.

Degree 3 DeFi - Non-custodial and have permissionless initiation of margin calls and provision of margin call liquidity, while the rest are centrally administered. Examples are MakerDAO, Compound.

Degree 4 DeFi - Non-custodial, having permissionless margin calls and provision of margin call liquidity, its price feeds are decentralized, while the rest two are centralized. Examples are dYdX, Fulcrum.

Degree 5 DeFi - Here, the interest rate determination is decentralized along with the first three components in Degree 4 DeFi, but the control for the platform developments and updates is centralized. Example - bZx.

Degree 6 DeFi - In the last category every component of DeFi should be decentralized. But as of now no DeFi protocol is completely decentralized.

4 SIMPLE STEPS TO EARN MONEY ON DeFi LENDING PROTOCOL

1. Get ETH into an address that you own. As the saying goes, "if you don't hold the private keys to the wallet, then they aren't your coins"

• Head to DEX.AG and sell most of that ETH for DAI. 

• Go to DeFi Pulse's Earn Income page. 

• Pick a lending protocol, and start earning interest.

2. Stablecoins - Tokens called stablecoins are also important to the DeFi ecosystem. You may be under the impression that all cryptocurrency is volatile. However, stablecoins are tokens designed to hold a specific value and are typically pegged to fiat currency like the US dollar. 

For example, DAI is a stablecoin pegged to USD and backed by ether (ETH). 

For every DAI, there is $1.50 of ETH locked into the MakerDAO smart contract as collateral.

3. Exchanges and Open Marketplaces

4. Issuance and Invest Management Platforms

Until the law completely adapts to DeFi services, there will always be some form of centralization. For example, take the case of buying a property on the blockchain. Though you can tokenize the deed, the law and the court of that country should recognize that.

How Decentralized Is DeFi Really?

In crypto space, it is said – “A system is decentralized only as its most central component.” This is part truth since decentralization exists in sequence and on multiple levels. The degree of decentralization in DeFi services varies since neither every component can be decentralized nor it should be.

Is There Any Risk Involved With DeFi?

With any high return product, there is always some risk involved and DeFi has its fair share too. Securely handling cryptocurrencies and finance tools require specialized knowledge, so of course, there’s a risk factor involved. It’s the user’s responsibility to keep their key and holdings secret, use a hardware wallet and multi-factor authentication.

The infamous DAO hack happened in June 2016. During the incident, the hacker managed to transfer one-third of DAO funds to another account by exploiting a vulnerability in its coding. This forced the Ethereum community to hard-fork the blockchain to restore the funds. 

DApp and smart contract security has since become much tougher, but it would be irresponsible to take it for granted. 

Some DeFi tools have gone through security audits – for example, Dai has received four security audits so far. Further, there are firms like The Nexus Mutual that have taken the initiative to develop insurance to cover issues like smart contract failure. As a DeFi user, you must keep yourself updated with the changing terms of services between various DeFi products, wallets, exchanges, and crypto projects. 

Some DeFi products can add new dimensions that are paired with DAOs that govern the protocol or platform. For example, MarkDAO token holders can vote on the stability fee of Dai, which has experienced its value varying between less than 1% to 20% so far. As with the traditional currency, investors usually use historical data and benchmarks such as the annual inflation of a currency and the risk-free rate of return to evaluate investment opportunities. 

But in the case of DeFi, the lack of extensive historical data and benchmarks makes it hard to assess the risk of investments in DeFi. To mitigate these risks, tokens like cDai (Compound Dai) have been proposed. cDai automatically gains variable interest using the compound lending protocol. 

This will allow users to invest in DeFi products relatively risk-free.

DeFi isn’t stopping anytime soon.

If you believe the future has digital money, then come explore what DeFi has to offer. As at 7th February 2020, the entire decentralized finance market had surpassed $1 Billion, and as of today, it stands at $45.60B, over 4,560% in the last 3 years. Ethereum has become the blockchain of choice for many companies to build their financial products. 

More and more DeFi applications are built every day. That’s such a huge passing if you ask me.

DeFi – Conclusion

The DeFi market is tiny compared to traditional finance, but it has picked up its pace rapidly since last year. With more projects and financial DApps we can expect to reach a genuinely decentralized financial reality where the traditional finance market is interoperating with digital assets and blockchain in perfect sync.