WHAT IS DEFI?
DeFi ; is an abbreviation of the phrase decentralized finance which generaly refers to the digital assets and financial smart contracts, protocols, and decentralized applications (DApps) built on Ethereum. In simpler terms, it’s financial software built on the blockchain that can be pieced together like Money Legos
Why is Defi the best decentralized project in finance?
The ability to borrow funds, take out loans, deposit funds into a savings account, or trade complex financial products — all that without asking anyone for permission or opening an account anywhere — is quickly gaining traction. The amount of money locked into various DeFi services has recently surpassed $2 billion, according to DeFi Pulse, up from about $1 billion a month ago. But it’s not just about the money — other assets are being sucked into the DeFi ecosystem.
DeFi, which is built on cryptocurrency platforms such as Ethereum and Cosmos, cuts out human middlemen and paperwork, and replaces them with smart contracts. These are computer programs that run on decentralized blockchains, meaning they’re near-impossible to stop or censor. If I borrowed money to someone via a smart contract, the terms built into the contract have to be obliged — no human can (typically) alter that.
In an article written six months ago by mashable discribing how simple it has become to invest, loan, and borrow money using freely available DeFi services, in his case a mobile cryptocurrency wallet called Argent.
Since then, however, the number of services in the DeFi space, as well as overall use, have skyrocketed. The simple practice of borrowing a bit of crypto and generating a return seems innocent in comparison to the massive array of opportunities available today.
Tokenization of everything
One advancement that facilitated this change is tokenization. Tokens — essentially cryptocurrencies that run on a parent blockchain, like Ethereum — are smart contracts themselves. Tokens on Ethereum share many properties with Ethereum’s currency, which is called ether or ETH. But they can be created with properties that make them similar to certain financial products and services. The most common example are stablecoins, which are tokens whose value closely tracks the value of a real-world asset, such as a fiat currency. USDC, TUSD and DAI track the dollar. EURS tracks the euro
During the past year or so, an increasing number of external assets and financial products have been tokenized on Ethereum. Bitcoin, which in itself does not offer complex smart contract capabilities, is a valuable and highly liquid cryptocurrency asset. It is therefore being injected into DeFi by projects which, typically, lock actual bitcoins as collateral and produce Ethereum-based tokens which track the value of real bitcoins. Examples include WBTC and tBTC. Some 15,500 bitcoins are currently locked into BTC services, with a total value of more than $141 million.
The relative ease with which new DeFi products and services can be created and offered to the market has caused a surge of interest, and some of it has the makings of a bubble.
The most shocking example of this is the practice of yield farming. DeFi products remove a lot of the friction that’s present in finance. Also, anyone can create them and place them on the market, with no restrictions or oversight. Because of these factors, it wasn’t long until certain DeFi services started offering extravagantly high returns on lending products. Then, other DeFi services were built on top of these, further increasing these returns by doing some fairly complex and — to a typical user — arcane wizardry in the background.
A site called DeFi Rate lists the typical lending interest rates for DeFi products. Right now, a platform called Nuo offers an 11.47 percent yearly return rate on USDC deposits, and Aave offers a 7 percent yearly return rate on DAI. If you’re not very tech-savvy and/or privy to the inner workings of these systems, you probably won’t know why one service can offer a premium over another. But a lot of users are focusing on the ones with the highest returns, which are typically associated with higher risk.
Buchman wrote that “there’s still a long time to go before these services are useful to an average person. In fact, it’s currently mostly based on speculation and arbitrage, and a lot of it comes with considerable risk.
Though in principle the mechanisms are much more transparent than any traditional financial product, the general volatility of cryptocurrencies, the immaturity of DeFi smart contracts (ie. the potential for bugs), and the possibility of miner interference (ie. “Miner Extractable Value”) collectively make DeFi a dangerous place to play.”