The Fullest Introduction to DeFi: Why is decentralized finance the second foray in the history of cryptocurrencies?
This article will reinterpret DeFi from the very beginning to the present development of the project, it is especially suitable for those who are new to the DeFi concept.
Starting with Bitcoin, blockchain has been around for more than ten years. Aside from the Bitcoin disruption, the latest real turning point for blockchain is the birth of the smart contract platform. The smart contract platform has brought in many new categories, the most important of which are finance and games. The game is mainly based on heterogeneous codes. In the future, a larger value field will be formed around the creation and trading of heterogeneous tokens. It is still in its infancy, but the exchange market is already stable and the financial sector is predominantly DeFi. Before we understand the importance of DeFi, let’s first understand what DeFi is:
What is DeFi?
It comes from the English language as decentralized finance, DeFi stands for this phrase, if translated closely, it means “decentralized finance”. But in fact, calling it “distributed finance” or “open finance” is more correct. Because, in essence, there is no fully decentralized finance, but mostly a combination of different levels of centralization and decentralization. However, DeFi was established by convention and more suitable for dissemination.
So what is DeFi specifically? It typically refers to crypto assets, financial smart contracts, and smart contract-based agreements (such as Ethereum). These assets, smart contracts, and agreements can be combined just like Lego, so they are also known as “currency Lego”.
DeFi is the second breakthrough in the history of encryption
The first foray in crypto history was Bitcoin, achieving the transfer of value without the need for third party involvement through the proper use of cryptography, consensus mechanisms, peer-to-peer networks, and Institutional incentives. From the present point of view, the initial store and value transfer phase has been basically reached, which is the most brilliant and successful first foray in the history of encryption.
And DeFi can be considered as the second breakthrough. Although it has not reached the peak of Bitcoin, it has already begun to take shape and has potential for growth.
Why is DeFi the second breakthrough in the history of encryption?
To understand DeFi, you must first understand why it exists. It exists because it can meet the financial needs of some people and these financial needs cannot be met by traditional finance:
- The economic and financial crisis is opaque
The core object of finance is money. And money is spontaneously produced in the development of human society, not by birth. Human exchanges are initially barter, but the biggest problem with barter is inefficiency, since it is difficult to find two people with the same needs, a fisherman who needs shoes and a shoemaker. need cereals. It is very difficult to reach an agreement between.
Even if there is a match, how many catties can be exchanged for a shoe? Pricing is another matter. Consequently, the demand for money appeared. People need a currency to exchange between different commodities. This currency becomes a medium of exchange and can store value. Currencies cannot buy 10 units today, tomorrow only 1 can. Up.
In human history, there were types of money like shells, precious metals, gold and silver, but today, they are legal currencies. Through the integration and operation of intermediaries, traditional finance improves market efficiency and achieves a better allocation of resources. But at the same time, due to the existence of intermediaries, the traditional financial system also presents many problems, such as obscurity and spam. This leads to excessive debt and inflation, when economic development stagnates or there is excessive inequality in economic distribution and a debt structure is not digested in time, a crisis. Health can easily explode.
In the current financial structure dominated by intermediaries, economic crises seem inevitable and repeatable. At the core of blockchain is transparency and distribution, giving it a chance to change the existing financial structure. This is the key to why DeFi can play a role in the future.
- DeFi is different
So far, DeFi is far from being successful, and even compared to Bitcoin’s forays, it’s still in its infancy. Compared with traditional finance, its size is not even a small fraction. But why is it important?
DeFi’s goal is to build a transparent financial system, open to all and without permission, without relying on third-party organizations to fulfill financial needs. Examples include loans, transactions, payments and derivatives.
It’s open finance, also brought about by the blockchain’s infrastructure, and its inspiration also comes from Bitcoin. Its most important features are verifiability and transparency. Through blockchain, everyone can verify every transaction taking place on it, which also brings transparency.
- DeFi is the currency Lego
With basic Lego modules, people can assemble different things according to their needs. The same goes for smart contracts in DeFi. Through various assets, contracts, and agreements, new projects can be assembled to provide users with new products and services.
For example, Compound is an Ethereum-based loan marketplace. In this market, you can borrow ETH, the Dai stable currency created by MakerDAO and the stable currency USDC is created with collateral in US dollars. When users offer Dai to Compound, users can get cDai tokens. cDai represents the user’s Dai and resulting benefits.
CDai itself is also a token, which means two things, one that cDai can be marketed and the holder can receive income. For example, if you trade cDai with ETH through Dex like Uniswap and hold cDai, then you can get cDai income. Secondly it can be used by other smart contracts, for example cDai can be used by Uniswap. Placing ETH or BAT on MakerDAO can generate Dai token and place Dai on the cDai Generating Compound, and cDai can be exchanged for other tokens on the uniswap. Here is a simple example of Lego currency.
- DeFi is a parallel world of traditional finance
Traditional finance has the advantage of middleman and has earned the trust of many through its services. This can satisfy most people’s needs in the real world. There are still a few people in the world who want to control financial services on their own, which is key to DeFi’s survival. To serve these people, DeFi is building a world that goes hand in hand with traditional finance.
Example: Compound, Dharma, Maker, etc. is offering a crypto asset lending service, similar to the encrypted version of traditional banks, i.e. DeFi banks. Projects like Uniswap, Kyber, Bancor and others offer asset exchange services, similar to the Nasdaq, the New York Stock Exchange and other exchanges in the traditional world of finance. They are DeFi version exchanges and can be exchanged as long as they have encrypted assets and wallets.
- DeFi is not just a parallel world of traditional finance
DeFi is not only a map of traditional finance in the crypto world, it also presents new features. For example, it recognizes the rapid exchange of funds through capital; Its borrowing rate can be adjusted instantly, and it can be added or withdrawn at any time and without the loan period of the traditional loan. Another example, its loan income is reflected in its token and if the user buys the token, he can basically enjoy the token’s loan income, which is the equivalent of coding debt and real circulation. Accelerating liquidity of assets. DeFi’s disapproval and transparency are out of the reach of traditional finance.
Since DeFi is a user that interacts with a series of smart contracts on the blockchain, everyone can use its transparent and permissionless features to profit, for example, through aggregation. DEX to achieve the best price deals; through the consolidation of loan agreements to achieve the best Interest income.
From a lending business perspective, DeFi’s current loan requires excessive collateral in order to obtain the loan. Since all loan and liquidation processes are agreed upon, there’s no need to worry about default or involve a third party. At the same time, by eliminating the intermediary links, the lender can get higher returns and the borrower can get better interest rates.
Of course, DeFi is not without risk, and this is also its downside compared to traditional finance. Although traditional banks also have a risk of bankruptcy, they are relatively stable and predictable. And DeFi projects may encounter black swan incidents, such as a rapid decline in crypto assets in the short term, leading to the risk of collapse due to being too late to liquidate; In addition, if there is a loophole in the code it could put a hacker attack.
- Integrating DeFi and traditional finance
Currently DeFi is a need of some, not just one. Not everyone has the ability and willingness to manage crypto assets. A more likely scenario is that DeFi and traditional finance form a merger, each with a group of users. Traditional finance can use DeFi’s characteristics to achieve liquidity and DeFi can use traditional and compliant financial assets to achieve scaling.
USDC is an example of a combination of DeFi and traditional finance. The current USDC lending business volume at DeFi is second only to ETH and even surpasses Dai. The USDC imports the traditional world currency into DeFi to form a stable currency, then uses DeFi’s disallowed, fast and transparent circulation features to do its part.
Traditional financial needs have its historical inertia. From today’s point of view, DeFi is difficult to expand without the involvement of traditional finance. While this is something many idealists and enthusiasts don’t want to see, DeFi can be used in the real world. The biggest role is to help traditional finance achieve a faster flow of assets through blockchain’s rapid and unauthorized circulation, so that many of the initially fortified assets can be regenerated.
Even Dai cannot achieve 100% pure decentralization, because its security requires the management of MKR token holders and it needs to prevent miraculous attacks on it. All of these require a certain degree of concentration in order to maintain Safety.
DeFi in itself is open finance and a new kind. It can make full use of the transparent, open, non-forgery, and intermediary properties of blockchain without repelling the traditional world of finance. If the two can find a way to merge, a new species will be created.
This will become more and more evident as real-world assets circulate on DeFi. For example, if you buy 100% tokens of a certain home, but that house involves many actual legal rights and obligations, you cannot automatically obtain all the rights and benefits. through token transfer. This requires the help of traditional law enforcement. To resolve disputes.
- DeFi and smart contract platform
Most of the current DeFi projects are based on the public Ethereum chain. The most important reason is that the building on top of the Ethereum blockchain has certain security, underlying asset value, and supports a developer’s ecology.
Project DeFi is a currency Lego, and it should have a good foundation. Although Bitcoin has the highest market value, it is not as flexible as Ethereum and cannot build smart contracts with complex logic.
Ethereum’s market value gives it security and it is a smart contract platform, leading to DeFi’s development on Ethereum. This can also be seen from the major current DeFi projects.
Of course, does this mean that other public chains have no chance? Not necessarily, it is man-made. The core logic here is not tps, but security. Therefore, if other public chains pass or surpass Ethereum’s DeFi, the first thing to do is realize the security of the public chain. One of the core premises is the increase in the value of the chain.
- DeFi’s participation and user habits
Since DeFi is not allowed, it means that anyone with crypto assets can participate in DeFi. For example, if a user owns assets such as Dai, USDC, ETH, etc., he can deposit the crypto asset into a DeFi project and earn interest income. These operations are usually accomplished through on-chain operations, with no third party involvement, and the user has a lot of freedom, convenience, and speed of participation.
Currently, through DeFi, people can perform services such as loans, transactions, payments and futures, but for most casual users with no experience of using crypto wallets, it has a certain threshold. It requires users to have certain abilities and experience in asset management.
However, as more and more DeFi projects are simplifying operations and becoming easier to use, once people use DeFi products, the difficulty of using them will decrease. Once the usage habits were formed, more and more people were entering the DeFi field.
The current DeFi projects status
- From lending, DEX to derivative products
The current DeFi project involves lending, DEX, financial derivatives and other businesses. According to the size of crypto assets locked at the time of writing, the total crypto assets locked are worth $ 686 million, of which nearly 2.7 million are locked with ETH and 1,400 are locked in BTC. DAI is over 22 million US dollars, nearly 100 projects are already operational and 16 projects have assets over 1 million US dollars.
These 16 projects are also the main DeFi projects currently, including MakerDAO, Synthetix, Compound, InstaDApp, Uniswap, dYdX, Nuo Network, Lightning Network, Bancor, WBTC, Kyber, bZx, Nexus Mutual, Set Protocol, DDEX , Dharma.
- DeFi Big Three
If you look at the value of current locked assets, Current MakerDAO, Synthetix, and Compound (at the time of writing) have lock assets of $ 329 million, $ 176 million, and 99 respectively, 6 million US dollars. They are DeFi’s current three small giants, and projects that remain ahead of the Three Big Gaps.
However, the DeFi model has yet to be determined. There are new smart contract platforms joining and new projects emerge. This field is just beginning. As a result, the so-called Big Three are just temporary leaders for now, and there will be more outstanding projects in the future.
DeFi will be recorded in the history of coding because it is truly relevant to the product and the market. So far, there have been two matches between products and markets in the history of cryptocurrencies, one being Bitcoin and the other DeFi. Although DeFi is still very small, following the current development trend of the Lego currency, the company not only tries to build a parallel field with traditional finance, but also tries to combine with traditional finance to achieve New features, this is a very interesting area worth exploring.