DeFi: what are decentralized finance and development advantages
The world of crypto assets has increasingly attracted the attention of the financial market. Bitcoin, for example, recorded consecutive highs throughout 2021-2022, reaching a historical value of more than $66 million in October. But it is not just the high prices that arouse the interest of investors: they are also keeping an eye on the opportunities opened up by blockchain. This technology guarantees security for transactions with cryptocurrencies and has enabled disruptive solutions, such as DeFi platforms. As for now, Kiss.software offers defi development services by their highly skilled specialists as soon as possible; at the same time, the quality of the services provided does not suffer from the speed of work.
What is DeFI and how does it work
DeFi is the abbreviation of decentralized finance, an English term for decentralized finance. This ecosystem emerged in 2015 with a premise very similar to that of bitcoin — a digital currency that intends to decentralize money and monetary transactions —, but its focus is on financial services. Through these platforms, it is possible to simplify taking out loans and insurance and facilitate the trading of assets, removing the role of intermediaries — banks, brokerages, and other financial institutions.
In this way, DeFi platforms allow investors, financiers, borrowers, sellers and buyers to trade and interact with each other directly. It is an interconnected system with open-source code — also known as open source — whose applications are stored within the blockchain. DeFi works through so-called smart contracts, programmable digital smart contracts that allow you to automatically execute a previously defined code.
Today, the leading decentralized Defi network is Ethereum. The ecosystem, however, can still not serve all users interested in using the platform. Therefore, it must undergo an upgrade plan that, if successful, will remove the limit on people who can join the system.
What is the importance of the ecosystem for the market, and what are the advantages of development?
The DeFi ecosystem is still in its infancy, but expectations are high for the changes it can bring to the broader economy. In addition to directly contributing to the creation of disruptive solutions in the sector, platforms dedicated to decentralized finance offer solutions to a series of problems in the financial market, such as centralization of control, inefficiency, bureaucracy and little transparency.
Like cryptocurrencies, DeFi platforms have a global reach and work on a peer-to-peer model; that is, negotiations are made directly between two people. Furthermore, they are pseudonymized and are open to everyone. Its operating cost is meager when compared to traditional banks since its operation eliminates expenses with offices, salaries and bureaucracy.
How can DeFi be used?
Now that you know what DeFi is and how it works, it’s interesting to understand how it can be used. Below are some possibilities:
- P2P lending. DeFi can serve as a peer-to-peer (P2P) lending network. It is a way of offering credit through operations carried out directly between people. Thus, the system can unite an investor who wants to lend money to those who need credit — including companies. The alternative works as a collective loan. Therefore, this network differs from what happens in banks and other financial institutions and promises to make the process more agile and even cheaper. Even small businesses would find it easier to get credit with fewer bureaucracies.
- Conversion of digital currencies. DeFi also allows users to exchange one type of digital currency for another, for example. This process is carried out through a DEX — an acronym for decentralized exchanges. With the service, users carry out digital transactions in the peer-to-peer universe through smart contracts, issuing orders to buy and sell crypto assets — among other operations — without the need for an intermediary.
- Stablecoins. The decentralized finance system also allows for the issuance of stablecoins, known as stablecoins. This term refers to cryptocurrencies that maintain a constant price without experiencing large variations over time. For this, it is common for them to be backed by fiduciary currencies, such as the dollar.
The Potential Risks of DeFi
Defi’s most striking and positive characteristics — openness, flexibility and adaptability — create risks that cannot be overlooked. Between January and April of this year, attacks on decentralized finance platforms were responsible for 156 million of the 432 million dollars stolen in digital currencies, according to a report by CipherTrace.
Therefore, at the end of October this year, FATF, the financial action group against money laundering and terrorist financing, called for global regulators to create rules to supervise individuals who own, develop or operate DeFi platforms. According to the institution’s report, some DeFi projects are more centralized than their marketing suggests and, therefore, should follow anti-money laundering rules applicable to virtual asset service providers.
There are numerous possibilities to develop protocols that simulate traditional financial market structures, for example, loans, asset trading, payments, and resource management. Among them, the main applications are:
Decentralized Exchanges (DEX)
Decentralized exchanges are cryptocurrency trading platforms where investors can trade with each other without intermediaries; that is, there is no third party that manages the assets, order book or custody.
It is the users who provide the liquidity for the transactions to occur, being executed through smart contracts, directly between the wallets ( wallets ) of both parties. Wallets are a digital wallet for storing and transferring cryptocurrencies, essential for using DeFi applications. Two examples of DEX are Uniswap and PancakeSwap.
To give you an idea, Uniswap, the largest DEX operating on the Ethereum network, recently surpassed the $1 trillion mark in cumulative trading volume, reflecting the importance of this application in the DeFi ecosystem.
Like traditional loan operations, lending platforms allow users to obtain cryptocurrencies using the ones they already have as collateral. Those interested in lending money deposit their assets in liquidity pools, which are mechanisms for generating liquidity and distributing income from operations. Two examples are AAVE and Compound.
The lending market has increased substantially since 2020, surpassing over $80 billion in Total Blocked Value (TVL). This metric shows the value users have deposited into a smart contract.
We emphasize that the aforementioned protocols are not investment recommendations.