What is DeFi?

4 Types of Decentralized Finance Projects Making Waves
Coin Cloud Team
, published on 
August 4, 2020
What is DeFi?

In recent blog posts, we’ve talked about Ethereum and Bitcoin dominance, and we’ve hinted at DeFi, which is enjoying a heyday right now.

DeFi (decentralized finance) uses decentralized networks to turn old financial products into transparent protocols that run without need of a third-party service provider (such as a bank). In short, it's a type of financial software built on the blockchain, allowing it to be put together piece by piece.

Cryptocurrency itself can be considered a DeFi application, but it’s more than that. It includes tokens, stablecoins (crypto-backed, not fiat-backed), and even exchanges, lending services and prediction markets. The majority of DeFi projects are built on the Ethereum platform, and that seems to be creating a bull run for cryptocurrency. Currently $4 billion is locked in DeFi applications.

Open Banking vs. Decentralized Finance

You might have heard of open banking and been wondering if it’s the same thing. While they’re related, open banking lets financial service providers access data through Application Programming Interfaces (APIs). An API is a piece of computer code that allows two apps to talk to each other, and you likely experience them almost every day, from payment processors to travel booking websites.

Letting two programs share information is great. But DeFi, on the other hand, doesn’t rely on current systems at all — it’s a totally new financial system that’s separate from current infrastructures. (To make matters more confusing, DeFi is sometimes called “open finance” … which, again, is not the same as “open banking.” Yeah, we know!)

DeFi focuses on building open-source financial services that are independent from traditional financial or political systems, with the goal of eliminating censorship and discrimination worldwide. If it gets adopted on a large enough scale, we’d be essentially taking power from centralized organizations — like banks and governments — and putting it in the hands of the people.

Here are four of the most popular types of DeFi projects:

1. Crypto-Backed Stablecoins

Dai and sister coin Sai are two of the few stablecoins that count as DeFi, since they’re pegged to cryptocurrency instead of fiat currency. This makes them global currencies that remain untouched by central banks or governments. While USD-backed stablecoins have some great advantages, they’re basically just IOU notes for the cash sitting in reserve, which isn’t decentralized enough to fall under the DeFi umbrella. Learn more about these and other stablecoins in our free downloadable Ultimate Guide to Digital Currency.

MakerDAO, the creator of Dai and Sai, is extremely dedicated to DeFi. They also have a MKR decentralized governance token that allows holders to vote on Maker Protocol policies, and a collateralized DeFi lending system.

2. Lending Services

Besides MakerDAO, there are a number of DeFi lending services currently battling for dominance. Compound Finance and Aave are the biggest next to Maker, and other contenders include Dharma Lever and Celsius Network.

Compound is like a money market fund, allowing you to earn interest on your crypto while Dharma lets you underwrite debt in order to gain returns on your investment. Aave’s new Aavenomics plan will transition their offerings to decentralized and autonomous governance, with their current LEND token migrating to AAVE tokens at a ratio of 100:1.

3. Decentralized Exchanges

A decentralized exchange (DEX) allows customers to trade cryptocurrency or stablecoins peer-to-peer, 24/7, without permission or centralized custodian. And unlike regular P2P platforms, where you meet somebody in a coffee shop and have to trust that they’ll deliver what you’re paying for, the DEX makes it happen automatically. In a super-brief nutshell, users deposit currencies into a pool that others can buy from, and the amount in the pool determines the price.

Popular DEXes include Uniswap, Curve.fi, Balancer and Synthetix. Services like Nuo and dYdX also allow you to hedge, short or margin trade like the stock exchange.

4. Prediction Markets

Betting platforms like the no-limit Augur lead the charge in the area of prediction markets. Helena lets you forecast blockchain events and projects. And if you’d like to make your own market, you can use Gnosis Protocol or the simplified Omen.eth, built on the Gnosis framework. Like all DeFi projects, you can use these services without a third-party bank or clearing house.

Risk vs Reward

This is just the tip of the iceberg. There are many more DeFi applications, which obviously have a lot going for them. The biggest risks are that the smart contracts that power them could be hacked, since the open-source nature means a lot of people develop the code over time. Either way, we'll be keeping an eye on developing DeFi projects.

Disclaimer: The information and views supplied on the Coin Cloud blog are for educational and entertainment purposes only. We are not financial advisors, so please do your research and consult with a trusted financial specialist before investing your money.

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