Decentralized Finance, or “DeFi,” as it is often known, has taken the crypto and blockchain world by storm. However, its recent recovery obscures its origins in the 2017 bubble phase. While everyone and their dog was undertaking a “Initial Coin Offering,” or ICO, few corporations saw blockchain’s promise beyond a rapid price increase. These trailblazers envisioned a world in which all financial applications, from trading to savings to banking to insurance, would be enabled directly on the blockchain, without the need for any intermediaries.
To grasp the possibilities of this revolution, consider having access to a savings account that pays a ten percent annual rate in USD but does not require a bank and poses virtually no danger of funds. Assume you can trade crop insurance with a farmer in Ghana while sitting at your Tokyo office.
DeFi Building Blocks
Before we proceed, there are three fundamental DeFi building blocks that you should be aware of:
- Automated market making or trading one asset for another without the involvement of a middleman or clearinghouse.
- For traders, speculators, and long-term holders, overcollateralized loans or the ability to “put your assets to use”, for example best bitcoin Casinos.
- Stablecoins are algorithmic assets that track the price of an underlying asset but are not centralized or backed by physical assets.
Understanding the Production of DeFi
Stablecoins are commonly utilized in DeFi because they resemble standard fiat currencies such as USD. This is a significant step because the history of cryptocurrency demonstrates how volatile things can be. Stablecoins, such as DAI, are meant to mimic the value of USD with tiny changes even during significant bear markets, i.e. even if the price of cryptocurrency crashes, as it did from 2018 to 2020.
Lending protocols are a fascinating development that is typically constructed on top of stablecoins. Imagine if you could lock up your assets worth a million dollars and then borrow against them in stablecoins. The protocol will automatically sell your assets if you don’t repay the loan when your collateral is no longer sufficient.
The entire DeFi ecosystem is built on automated market makers. Without it, you’re stuck with the conventional financial system, which requires you to rely on your broker, clearinghouse, or exchange. AMMs, or automated market makers, allow you to swap one asset for another based on a reserve of both assets in their pools. External arbitrageurs are responsible for price discovery. Liquidity is pooled based on the assets of others, and they have access to trading costs.
You can now obtain exposure to a wide range of assets while remaining entirely within the Ethereum ecosystem and never having to engage with the traditional financial sector. You can profit by lending assets or acting as a market maker.
This is a fantastic breakthrough for the developing world because it now gives them access to the entire range of financial systems in the developed world with no obstacles to entrance.