💸 Into the World of DeFi

DeFi is bringing a revolution into the world of finance. But can it achieve all that it has promised?

DeFi.

We're sure you’ve come across this word at least once.

And while you may know that it means “decentralised finance”, have you ever wondered why finance needs to be decentralised?

The Need For DeFi

DeFi was born out of the same needs as crypto was: to give people control over their money.

Most of our money is stored, controlled and regulated by financial institutions like banks. 

They determine when, where and how much you can withdraw and transfer.

And when you want loans, you have to jump through hoops to get them. Oh, if you have a bad credit score or even no credit history, forget about it.

While cryptocurrencies addressed some of these problems, they couldn't untangle all the knots in the financial system.

Enter: DeFi

DeFi is a decentralised financial system built on blockchain tech, eliminating all third parties.

Yes, even the creators of a DeFi platform cannot dictate what you do with your money.

Every member using the network can vote about what it should do in the future. Their voting power depends on the number of network-specific tokens they hold. How do they get these tokens? By conducting transactions (these tokens can also be bought).

So, it's like giving shareholders complete control over the decisions of a company.

Building Blocks of DeFi: DeFi Protocols

DeFi protocols are a set of rules (computer code) that govern the activities in a DeFi ecosystem to overcome the traditional finance pitfalls. 

They facilitate lending, borrowing, trading and other financial activities. But, how do they work without intermediaries or supervisors?

By using blockchain-based smart contracts, that dictate exactly how these protocols will function. 

For instance, DeFi protocols allow you to take flash loans (instant loans with no collateral). 

The smart contract here is smart enough to guarantee that the loan amount is not lost. If the borrower doesn't pay back the loan in the given time, the whole transaction will be cancelled and your crypto will be returned. Easy!

Here are some of the most popular DeFi protocols:

• Aave: Aave is one of the largest crypto lending protocols. It acts just like a bank - you lend, you earn interest; you borrow, you pay interest. 

  Say you want to borrow 10 BTC. You would have to put more than this amount in a different cryptocurrency as collateral. This is because of crypto volatility. In case your collateral amount can no longer cover the borrowed amount, your collateral can be liquidated to cover the cost of your loan. 

  Why not just sell your crypto? Because it could fetch a higher price later.

  The Aave protocol is like a huge pool from which thousands can either draw crypto or add crypto. Essentially, it is a pool-to-peer lending platform that supports over 20 cryptos. 

• Uniswap: The Uniswap protocol (built on the Uniswap decentralised exchange) is a peer-to-peer system that helps you swap cryptocurrencies on the Ethereum blockchain. At the core, it ensures higher liquidity for cryptocurrency pools. 

  Centralised exchanges like Binance use the traditional order book-based trading: Buy and sell orders are added to a list. For a successful trade to be executed, there has to be a match between a buy order and a sell order. This reduces liquidity, meaning a trade fails if there’s no match found. 

  Uniswap has a solution for this: automated liquidity protocol. 

  Users pool their crypto to create a fund that is used to execute all trades on the platform. Each token has its own pool, and the prices are determined using an algorithm. So, users don't have to wait for a match to complete a trade: the pool is always there. Easy, no?

  But why would people contribute to the pool?

  Because they are incentivised with tokens. Say if you contribute $1,000 to a liquidity pool of $10,000, you would receive tokens for 10% of that pool. You can then exchange or redeem them.

There are many such DeFi protocols that have now taken the world by storm. 

But Are DeFi Protocols the Solution to All Our Problems?

While DeFi protocols may have solved a lot of problems plaguing traditional finance, they are still a work-in-progress. One of the biggest concerns with DeFi projects is scalability.

People are jumping onto DeFi projects like no other, but this huge traffic causes the system to slow down. Currently, $78 billion has been invested in DeFi protocols. So much so that Ethereum can only process 15 transactions per second at full capacity! And high traffic also causes Ethereum gas fees (transaction fees) to increase. 

And, is it truly decentralised? People with deep pockets who bought large amounts of crypto tokens have all the power, so they can call the shots. 

Plus, in a world where only 69% of the global population has a bank account, how accessible do you think this blockchain-driven financial system is? Do we have the infrastructure to make this shift?

DeFi has the potential to become the future of finance. But, there’s still a lot to fix.

Will DeFi be able to do so? 

We've barely scratched the surface of DeFi. If you want us to cover more about these protocols in detail, comment below!

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