Decentralized Finance in Ethereum (DeFi): The Future of Finance?

Decentralized Finance, or DeFi for short, has taken the world of cryptocurrency and blockchain by storm. However, his latest revival hides its roots in the 2017 bubble era. While everyone and their dog was dealing with the “Initial Coin Offer” or ICO, several companies saw the potential of the blockchain as far removed from a quick gain in price. These pioneers envisioned a world in which financial applications, from trade to savings, banking, and insurance, would be possible in a blockchain without intermediaries.

To understand the potential of this revolution, imagine that you have access to a savings account that earns 10% a year in US dollars, but without a bank and virtually no cash risk. Imagine being able to trade in product insurance with a farmer in Ghana sitting in your office in Tokyo. Imagine that you can be a market maker and earn as much interest as every Citadel wants. Sounds too good to be true? It’s not. This future is already here.

DeFi’s building blocks

Here are some DeFi building blocks you need to know before moving on:

  • Creating or exchanging an automated market with one asset reliably with another without an intermediary or clearing house.

  • Extremely secured lending or the ability to “put your assets to use” for traders, speculators and long-term owners.

  • Stablecoins or algorithmic assets that track the base price without centralization or support by physical assets.

Understand how DeFi is made

Stablecoins are often used in DeFi because they mimic traditional fiat currencies such as the US dollar. This is an important development, because the history of cryptocurrency shows how changeable events are. Stabilcoins like DAI are designed to track the value of the USD with small deviations, even during strong bear markets, ie even if the price of the cryptocurrency falls as the bear market in 2018-2020.

Credit protocols are an interesting development, usually based on stablecoins. Imagine being able to freeze your $ 1 million assets and then borrow them in stablecoins. If you do not repay the loan when your collateral is insufficient, the protocol will automatically sell your assets.

Automated market makers form the basis of the entire DeFi ecosystem. Without it, you are stuck with an old financial system that you have to trust your broker, clearing house or stock exchange. Automated market makers, or AMMs for short, allow you to trade one asset to another based on the stock of both assets in their pools. Price discovery occurs through external arbitrage. Liquidity is consolidated based on other people’s assets, and they gain access to trading fees.

You can now be exposed to a large number of assets in the Ethereum ecosystem and without ever contacting the traditional financial world. You can make money by lending assets or by being a market maker.

This is an amazing innovation for the developing world, because now they have access to a full set of financial systems in the developed world without any barriers.