As the market for cryptocurrencies continues to thrive and grow, so does the need for experienced developers. It’s easy for newcomers to get caught up in the hype, but diving into the blockchain technology can be quite overwhelming. This is where DeFi comes in. DeFi is short for decentralized financial infrastructure. It’s a type of platform that provides users with services such as lending, trading and investing without having to trust a central party such as a bank or stock exchange.
With these types of platforms, investors no longer have to rely on third-parties or centralized entities when trying to make investments or trade their cryptocurrency assets. This blog post will teach you about DeFi, its significance and how it can help you save time and money when making crypto transactions.
Since decentralized finance is designed to create a whole new financial system, advisors should understand this space as DeFi continues to evolve and grow.
Among the most important topics relating to cryptocurrencies is decentralized finance (DeFi), or a new financial system that is completely separate from traditional finance (TradFi). DeFi is a goal being pursued by billions of dollars, as well as thousands of developers around the world.This is part one of our series on DeFi. As part of this series, we will take a deep dive into this space for financial advisors in order to further our understanding and build a bridge that we can utilize to connect the TradFi world that we are used to with the new and innovative DeFi space that is being created.
Introducing DeFi: Open Source Cryptocurrency Movement Based On Ether
In 2013, programmer Vitalik Buterin co-created Ethereum as an additional cryptocurrency project after his work on Bitcoin. Unlike Bitcoin, Ethereum is designed to be a blockchain that can be used for multiple purposes: to be a digital currency, to be used for global payments, and to be a platform for multiple kinds of blockchain applications. Ethereum hosts an entire digital economy, such as DeFi, an open-source cryptocurrency movement based on ether. DeFi is open to anyone with an internet connection worldwide. DeFi is a trustless application, which means that the applications are not controlled or hosted by a central party like a bank. This decentralized financial system is possible due to aspects of cryptocurrency, such as cryptography, smart contracts, and blockchain technology.
Solidity, the language Ethereum uses for smart contracts, allows for all the logic necessary to create financial contracts to be included in the application code. Ethereum competes with other cryptocurrencies, such as Avalanche, Terra, Fantom, and others, for the right to run DeFi applications, but it is important to remember that Ethereum is the largest network and was used to create DeFi.
A first-generation DeFi platform built on top of the Ethereum blockchain was launched in 2015 called MakerDAO. MakerDAO allows users to lock ether, or ETH, with smart contracts, and create dai, a stablecoin linked to the dollar. With the help of stablecoins and smart contracts, MakerDAO’s Oasis platform functions as a decentralized bank.
LAn Introduction To Lending And Borrowing In The Decentralized Finance Ecosystem
Users can lock crypto positions into smart contracts and borrow against them, making lending and borrowing an essential part of the DeFi ecosystem. DeFi users can lock into a smart contract their crypto holdings and generate yield by allowing their coins to be loaned to borrowers.An interesting point to note is that lenders in the DeFi ecosystem generate yields substantially higher than traditional lenders. Smart contracts are much more cost-efficient than traditional banks; therefore, nearly all of the yield generated from lending money is returned directly to the lender via the smart contract. These transparent smart contracts have gained a lot of trust from people and have enabled them to generate a lot of income.
In a world of ultra-low interest rates, the cost-effective smart contracts are providing a technological solution to this problem. Interest rates are too low, and people are frustrated with central bankers for allowing them to be so low. However, a solution is not found through political persuasion, but through technology, which has yet again created opportunities for both borrowers and savers. Perhaps it would be wise to hedge your bets on the traditional banking system through building a robust DeFi portfolio.
In the lending and borrowing category of DeFi, compound is another popular application, an autonomous algorithm that allows users to provide crypto assets and generate interest. COMP is its native cryptocurrency. According to DeFi Pulse, there are currently $8.9 billion locked into Compound contracts. Additionally, Compound users can borrow stablecoins (with interest) and borrow crypto assets such as ETH. This is similar to the idea of borrowing dollars against appreciated securities in traditional finance.Anyone can lock assets into the With Compound protocol, holders of positions can earn compound interest on their positions immediately. Unlike traditional banks, Compound interest rates adjust based on supply and demand. Tokens supplied to the Compound protocol are credited with cTokens, which represent underlying assets generating interest and acting as collateral for the user. The compound user can borrow up to 50% of the value of their cToken. There are liquidation points on the borrowed position, like traditional financial systems. The compound user has immediate liquidity and can withdraw their assets at any time.
Aave and flash loans
Another large lending and borrowing platform in the DeFi ecosystem is Aave. Similar to Compound, AAVE is a non-custodial, open-source protocol running on Ethereum. It’s native currency is AAVE. AAVE smart contracts currently store $11.8 billion in crypto assets. Users can lend or borrow crypto assets with AAVE. By supplying assets to the protocol, lenders earn a yield on their assets. Like Compound, this yield adjusts according to supply and demand on the market.
Aave also offers a unique service called “flash loans.” A flash loan is a “one block borrow transaction,” which is a transaction where a user borrows and pays back a loan within the same block. The smart contract allows only the borrow and repayment of the loan to occur in the same block. Arbitrage and quick trading are made possible with the use of this technology. This is a new type of lending not available in traditional finance and is seen as a major enhancement to the TradFi system.
This CoinDesk explainer explains how flash loans allow traders to “take advantage of price discrepancies between a number of exchanges” in the crypto ecosystem. Consider two markets where pizzacoin is priced differently. On Exchange A, it is priced at $1, while on Exchange B, it is priced at $2. Through a flash loan, a user can purchase 100 pizzacoins at Exchange A for $100, then sell them for $200 at Exchange B via a separate smart contract. In turn, the borrower repays the loan and pockets the difference.” Accordingly, flash loans help stabilize cryptocurrency exchange prices and lead to greater economic growth.
What is a DEX?
DeFi, through the creation of smart contracts, stablecoins, and lending and borrowing platforms, has created another important innovation: trading volume on DEXs reached over $1 trillion in 2021, another key component of decentralized finance. Next in this series, we will examine how DEXs were created, their value to the crypto economy, their interactions with lending and borrowing platforms, and how their existence benefits users.
Why DeFi is so important
DeFi’s goal is to create an open and permissionless financial market. The advancement of DeFi has seen considerable development and investment, and financial advisors need to have a thorough understanding of this space. Many of the technologies in the DeFi space are built upon, and improve upon, the TradFi system, resulting in better outcomes for your customers. As decentralized finance continues to develop, it is vital to become familiar with it and be ready to rely on, and interact with, these applications.
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