A Beginner Guide On Decentralized Finance
Decentralized finance, or DeFi for short, is a budding industry built on the blockchain. It consists of protocols and applications that allow users to borrow, lend, and trade cryptocurrencies and other digital assets in a decentralized manner.
DeFi has seen a large growth in recent months, with over $239 billion of total value locked in DeFi products. This translates into a nearly 40,000% rise since 2020, according to a new research report. So what’s driving this growth?
There are a few key reasons for DeFi’s popularity. Below, we’ll go over all of them. But first, what is DeFi?
Basics of decentralized finance
Decentralized finance (DeFi) is a broad umbrella term that encompasses all financial products and services that are built on or around decentralized technologies. This includes everything from protocols that allow for the tokenization of assets to peer-to-peer lending and decentralized exchanges. DeFi has gained a lot of traction in recent months with the launch of many new products, and it is quickly becoming one of the most exciting areas of blockchain development.
Most people are familiar with centralized finance, which relies on a small number of entities to control the flow of money around the world. In contrast, decentralized finance (DeFi) is built on distributed systems and allows for a more open, equitable, and inclusive financial system. DeFi applications are powered by blockchain technology and use smart contracts to automate trust-less interactions between participants.
Some of the key features of DeFi include:
- Decentralized services allow for peer-to-peer trading of assets;
- DeFi applications don’t have a broker or any other intermediary’s fees to charge for using their services;
- Users’ money is stored in a digital wallet instead of a centralized bank account;
- Decentralized finance is inclusive, thus allowing any user to access DeFi services;
- Transfers are quick and easy.
Decentralized finance vs centralized finance
The centralized financial system we have today is riddled with problems. Fees are high, it’s difficult to get a loan, and there’s little competition. Decentralized finance has stepped in as a viable alternative to legacy institutions and bureaucratic processes.
DeFi applications aim to reduce the need for trust between participants, making the financial system more efficient and vulnerable to censorship.
And although DeFi is still in its early days, it offers some advantages over centralized finance:
- Decentralized and permissionless – no intermediaries to validate the transactions.
- Immutability – the blockchain data is nearly impossible to alter.
- Open and interoperable – DeFi services can work and interact with each other and transfer digital assets.
- Composable – DeFi services can be used in tandem to enhance the experience.
- User centricity – incentive models reward the user for participating in the service.
Now that you are better aware of the DeFi fundamentals, let’s have a deeper look at top DeFi applications.
Best DeFi applications in 2022
Decentralized finance is a rapidly growing field with new applications mushrooming every month. Below, we’ve listed the most popular ones.
Decentralized lending
These DeFi platforms provide loans to businesses and individuals with no intermediaries or long approvals. Decentralized lending services automatically execute loan terms based on smart contracts and distribute interest. To borrow money, you will need to provide the platform with crypto or fiat collateral.
Aave, MakerDAO, and Compound are among the most popular decentralized lending platforms.
Decentralized applications
DApps or decentralized apps look similar to regular applications and offer similar functions. However, the dApps backend relies on smart contracts that allow them to operate on a peer-to-peer network, such as a blockchain. It means that no centralized entity has control over the network.
Moreover, dApps have some distinctive features that make them a standout in the niche:
- Flexibility – since the vast majority of dApps are developed on the Ethereum blockchain, they allow for rapid development and deployment.
- Fault tolerance – the network is insusceptible to hacker attacks provided the smart contract is secure.
- User privacy – users don’t have to provide personal information, so data is kept private.
- Data integrity – data stays resistant to change since it is stored on the blockchain.
Stablecoins
This DeFi application is a bridge between the crypto world and centralized currencies. A stablecoin is a cryptocurrency that is pegged to another asset, usually fiat currency. This means that the value of the stablecoin remains relatively consistent, unlike other cryptocurrencies which can be highly volatile.
Stablecoins are often seen as a safer investment than other cryptocurrencies, and several have been launched in recent months. The most well-known stablecoin is Tether, which is pegged to the US dollar.
DeFi gaming
Decentralized games stepped onto the scene as a shift from the play-to-earn model. Here, users are rewarded with crypto assets, including NFT and native tokens. The latter can be then traded on digital asset markets, instead of being locked on centralized servers.
Blockchain gaming also paves the ground for the metaverse where compatible NFT assets can migrate across meta-worlds. AlienWorlds, Splinterlands, and Farmers World top the index of the most popular DeFi games, according to Dapp Radar.
How to develop DeFi services?
Strategy Development
No software project gets off the ground without a holistic strategy. Therefore, your Business Analyst team should perform market research to uncover functional and non-functional requirements of the future solution. This set of requirements then lays the ground for a Minimum Viable Product which is an early version of your DeFi application.
Design
Design architecture is one of the most challenging parts of DeFi development. Since decentralization is in its early stage, there are no design guidelines to assist designers. Overall, all DeFi services should have a user-friendly and easily discoverable interface.
Development and Testing
Once the final layout is ready, developers shape your idea into a full-fledged product. Whether it’s smart contract development or a lending platform, the development is done in iterations to promote flexibility in the process.
The Final Word
The world of decentralization is gaining momentum each day with new DeFi services catering to users. Unlike traditional finance, DeFi allows for accessibility and data privacy, which secures its place in the hearts and minds of users.