DeFi 101: A Guide for Investors in Crypto

AAX

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?

That’s right.

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 surpasses the initial goal of Bitcoin. Namely, to create a decentralized peer-to-peer (P2P) payment system.

With a total market cap of $1.11 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.

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 to 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 pair you with a lender who loans you money.

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.

In this section, we’ll explore the most common products and services in the decentralized finance space.

Currently, borrowing and lending products are the hottest apps in the DeFi market.

The two largest DeFi dApps (by market cap) — MakerDAO and Compound Finance — have a combined market share of 77.5%.

These platforms allow people to either borrow funds by using their cryptocurrency as collateral or earn interest by lending out their digital assets to other users.

Top platforms like Maker and Compound feature other products within their dApps (e.g., stablecoins) and access to other DeFi services.

Examples of lending and borrowing DeFi products:

  • MakerDAO: a decentralized credit platform
  • Compound Finance: an algorithmic money market protocol
  • InstadApp: an intuitive interface on top of MakerDAO helping users that lack the necessary technical and financial experience

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:

  • IDEX: a DEX featuring real-time token exchange
  • Bancor: a decentralized liquidity platform
  • Atomex: a multi-currency wallet featuring a built-in atomic swap exchange

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.

Examples of DeFi payment services:

  • Whisp: a decentralized payroll solution featuring crypto payments
  • Lightning Network: a network built on top of Bitcoin featuring smart contracts as well as low-cost and fast off-chain payments
  • Request Network: a decentralized network that allows users to request, validate, and execute payments

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.

  1. 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.
  2. Bitcoin: With the implementation of the Lightning Network, Bitcoin has become the second-largest DeFi blockchain, supporting 24 decentralized finance apps.
  3. EOS: Smart contract platform EOS, Ethereum’s main competitor, comes behind Bitcoin as the third most popular blockchain that hosts 21 DeFi apps.

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 coin profiles on AAX Academy.

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