Categories
Uncategorized

What is DeFi?

DeFi is an abbreviation for decentralized finance and is a set of services found in traditional finance implemented on the blockchain. The vast majority of DeFi activity is occurring on the Ethereum blockchain but this will most likely evolve as the ecosystem matures. The DeFi ecosystem is based around the ERC-20 token standard.

Stable Coins

Stable coins are pegged to the price of another asset (or assets), usually the US dollar, and are a core part of DeFi. They are useful as a medium of exchange, a store of value in between trades and as collateral in DeFi lending protocols. Stable coins are one of the foundations of the DeFi ecosystem.

Wrapped Coins

Wrapped coin are similar to stable coins in that their value is pegged to an underlying asset. In the case of wrapped coins the underlying asset is another crypto currency. The most common wrapped coins are Wrapped Bitcoin and Wrapped ETH. Wrapped Bitcoin allows Bitcoin to be used on the Ethereum network by presenting it as and ERC-20 compatible coin. Although ETH is the base currency for the Ethereum network, it is not ERC-20 compatible. Wrapped ETH allows ETH to be traded with other ERC-20 tokens.

Borrowing

There are many DeFi lending protocols that allow token holders to borrow against their crypto holdings. The main use case for borrowing is for leverage. An example being a holder of Ethereum borrowing (usually a stable coin ) against their holdings and using the borrowed funds to purchase more Ethereum.

Lending

Lending protocols require assets that can be borrowed. If a token holder plans on holding their tokens for a long period of time they can choose become a liquidity provider. A liquidity providers locks their tokens via a smart contract and in return they earn interest. The lending protocol can then use the locked tokens to lend to other users.

Decentralized Exhanges

Exchanges such as Coinbase are known as custodial exchanges. When using custodial exchanges you are actually giving custody of your tokens to the exchanges. This means that the tokens are stored in a wallet controlled by the exchanges. If the exchange is hacked or just dishonest the user can lose their tokens. Another drawback of custodial exchanges is that the exchanges will often keep any airdrops.

Decentralized exchanges are non-custodial and are automated using smart contracts. Users remain in control of their tokens at all times. This eliminates the dishonest operators and also allows token holders to keep any airdrops they are entitled to.

Insurance

All four services above are exposed to smart contract risk. This risk is very real and is the consequence of bugs that may be present in the smart contracts used for a given service. There are numerous examples of stolen or permanently frozen funds caused by smart contract bugs. There are a growing number of insurance protocols to protect against financial losses arising from issues caused by smart contracts.