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

Decentralized Finance, or “DeFi” for short, has taken the crypto and blockchain world by storm. Although it has recently experienced a resurgence, its roots date back to the 2017 bubble era. While everyone and their dog was doing an “Initial Coin Offering” or Few businesses realized that blockchain technology had more to offer than just a quick price increase. These pioneers imagined a world in which all financial applications, including banking, trading, savings, and insurance, could be carried out directly on the blockchain without the need for any middlemen.

Imagine having access to a savings account that pays out 10% annually in US dollars, but without a bank and with virtually no risk to your money, to get an idea of the potential of this revolution. Consider being able to exchange crop insurance with a farmer in Ghana while seated in your Tokyo office. Think about having the ability to act as a marketmaker and earning fees in the form of a percentage that every Citadel would desire. Sounds too good to be true, do you think? This future is not yet upon us.

Building blocks of DeFi

There are some basic building blocks of DeFi that you should know before we move ahead:

• automated market making, or the trustless exchange of one asset for another without a middleman or clearinghouse.
• Overcollateralized lending or being able to “put your assets to use” for traders, speculators, and long-term holders.
• The price of an underlying is tracked by stablecoins or algorithmic assets that are not centralized or backed by physical assets.

Understanding how DeFi is Made

In DeFi, stablecoins are frequently used because they resemble conventional fiat currencies like the USD. Given how unstable things are and how the history of crypto illustrates this, this is a significant development. Even during severe bear markets, i.e. even if the price of crypto is crashing like the bear market of 2018-2020.

Usually built on top of stablecoins, lending protocols are an intriguing development. Imagine being able to borrow money in stablecoins by locking up assets worth $1,000,000 and using that as collateral. If you don’t pay back the loan when your collateral is no longer sufficient, the protocol will automatically sell your assets.

The core of the entire DeFi ecosystem is automated market makers. Without it, you’re forced to use the antiquated financial system, where you have to have faith in your broker, clearinghouse, or exchange. Using a reserve of both assets in its pools, automated market makers, or AMMs for short, allow you to trade one asset for another. External arbitrageurs are used for price discovery. Others’ assets are used to pool liquidity, and as a result, they can access trading commissions.

You can now gain exposure to a wide range of assets within the Ethereum ecosystem and without ever interacting with the conventional financial world. Asset lending and market-making are two ways to earn money.

The developing world now has unrestricted access to the full range of financial systems used in the developed world, which is a fantastic innovation.