Decentralized finance, or “DeFi” for short, has taken over the crypto and blockchain world. However, its recent revival masks its roots in the 2017 bubble era. While everyone and their dog were doing the “Initial Coin Offer” or ICO, few companies saw the potential of the blockchain far above the rapid price increase. These pioneers envisioned a world in which financial applications from trade through savings to banking to insurance would be possible simply on a blockchain without intermediaries.
To understand the potential of this revolution, imagine having access to a savings account that yields 10% per annum in USD, but without a bank and virtually no risk of funds. Imagine being able to trade crop insurance with a Ghanaian farmer sitting in your Tokyo office. Imagine being able to be a market market and earn fees as a percentage of what each citadel would like. Sounds too good to be true? It’s not. This future is already here.
DeFi building blocks
There are a few basic blocks of DeFi that you should know before we move on:
An automated market creates or replaces one asset with another without trust without an intermediary or clearing house.
Pre-collateralized lending or the possibility of “use of property” for traders, speculators and long-term owners.
Stablecoins or algorithmic assets that track the price of an underlying asset without being centralized or supported by physical assets.
Understanding how to make DeFi
Stablecoins are often used in DeFi because they mimic traditional fiat currencies like the USD. This is an important development because the history of cryptography shows how changeable things are. Stablecoins like DAI are designed to track the value of the USD with smaller deviations even during strong bear markets, i.e. even if the price of the crypto-fall falls like the bear market 2018-2020.
Lending protocols are an interesting development that is usually built on stable coins. Imagine if you could lock up your million-dollar property and then borrow against it in stable coins. Protocol will automatically sell your property if you do not repay the loan when your guarantee is no longer sufficient.
Automated market makers form the basis of the entire DeFi ecosystem. Without it, you are stuck with an inherited financial system in which you have to trust your broker, clearing house or exchange office. Automated market makers, or AMM for short, allow you to exchange one asset for another based on the reserve of both assets in their pools. Price disclosure occurs through external arbitrators. Liquidity is pooled based on someone else’s assets and they gain access to trading fees.
You can now be exposed to a wide range of assets in the Ethereum ecosystem and without the need to interact with the traditional financial world. You can make money by borrowing property or being a market maker.
For the developing world, this is an amazing innovation because they now have access to a whole range of financial systems in the developed world without barriers to entry.