What does Decentralized Finance, or DeFi for short, actually mean? What use cases already exist for decentralized finance applications? And what are the opportunities and risks of DeFi? Peter Grosskopf, co-founder and CTO of Unstoppable Finance, sheds light on the DeFi darkness and answers the questions mentioned.
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What Is DeFi?
In 2015, Ethereum was the first blockchain to support smart contracts. These smart contracts allow software developers to write programs that run on the Ethereum blockchain and use it to settle payment flows. These programs, or “protocols” as they are also known, can provide financial services — for example, trading, lending and borrowing, automated indexing and portfolio management, and more. Decentralized Finance, or “DeFi” for short, refers to these financial products and services.
It wasn’t until the “DeFi summer” of 2020 that these protocols first became popular in the crypto community. Due to the lockdowns during the Corona pandemic, crypto users started to get acquainted with trading protocols like Uniswap and lending protocols like Aave. Users navigate the DeFi protocol’s website and connect to their Metamask wallet packaged as a browser web extension before initiating transactions in the browser and approving them in the wallet.
The novelty of these protocols is that they enable financial activity without a central service provider. When users place a trade on a decentralized exchange, for example, they do not interact with a single counterparty but instead deposit one asset into a pool of two assets and leverage another support away. The assets in the collection are provided by “Liquidity Providers,” who earn a portion of the pool’s trading fees that they provide. Similarly, when using a decentralized protocol to take out an over-collateralized loan, users draw from a pool of assets that other users earn interest. The lower the holdings of an investment in a collection,
DeFi Benefits Include Automation And Transparency.
Because DeFi protocols rely on their users for demand and supply, they present a unique opportunity for those willing to commit their capital. Anyone who deposits funds into such a pool earns a share of that pool’s trading fees; likewise, anyone who deposits into a credit pool makes interest. The returns that users can achieve vary independently of interest rates in the traditional financial system and are typically much higher than the interest rates offered by banks and other financial institutions.
The beauty of DeFi is that anyone can use a wallet to plug into the blockchain and either take on the role of a market participant – i.e., paying fees for transactions, trading, lending, etc. – or a market maker to earn something to contribute to the stability and liquidity of the ecosystem. There is no central trading or lending desk, and all participants interact trustlessly via these cryptographic protocols.
So any DeFi protocol is simply a set of rules that dictate how financial services are delivered and how supply and demand are balanced. The source code of each protocol is typically open source and publicly viewable, and the trades and activities that take place in each protocol are also available in real-time on the blockchain.
Since every transaction is logged on the blockchain, it is also straightforward for users to experiment with different wallets, profit and loss monitoring, and tax software. Simply entering a blockchain address is enough to view transactions with specific tools, and entering a private key is enough to start using a wallet. Users can use as many different wallet software solutions as they like – asset balances and historical transactions are reflected across all of them as this data is stored on the underlying blockchain. The entire ecosystem of decentralized financial services is accessed through wallets, which play a similar role to the web browsers of the early internet.
This transparency of DeFi will also fundamentally change how regulators work, as they can see every transaction and track funds through the ecosystem. Once users or companies are tied to a specific address, their whereabouts can be tracked. This is why crypto and DeFi are known as “pseudo-anonymous” – addresses are not linked to individuals by default but are visible to all.
An Era Of Crypto Applications Has Begun.
It is clear that the crypto trading hype is over, and an era of “crypto utility” is beginning. This is evidenced by the growing popularity of DeFi protocols over centralized financial service providers like exchanges. The largest decentralized exchange, Uniswap, trades over $1 billion in volume daily and generates over $4 million in liquidity provider fees.
Trading volume on decentralized exchanges increased from near zero before 2020 to nearly 15% of the total on centralized exchanges, and this ratio continues to rise. The shift from centralized to decentralized service providers is also evident. Throughout 2020 and 2021, Ethereum supply on centralized exchanges dropped from 20% to 12%, while the percentage of supply locked into DeFi protocols increased from 12% to 28%.
The number of daily transactions on the Ethereum blockchain is increasing, as is the number of unique addresses, ownership of NFTs, etc. And yet we are only scratching the surface of DeFi’s disruptive potential, as its peak market size is $250 billion. US dollars are still only a fraction of the multi-trillion-dollar private banking market. More importantly, the disruptive impact of DeFi and crypto is not limited to finance, as demonstrated by the rise of NFTs and gaming and the entry of well-established brands like Nike and Adidas.
Wallets Are The Gateway To DeFi.
Despite DeFi’s rapid growth, there remains a vast untapped market. User experience and security need significantly improved, which is the task for wallet providers. Access to this new digital economy of financial services is through these wallets, which play a similar role to the web browsers of the early internet. Unfortunately, most DeFi wallets still need to be simplified for mainstream users. The pace of innovation in DeFi is impressive, but using crypto wallets to discover and use the right products still poses a significant challenge – especially for non-technical users.
That’s why Unstoppable Finance is dedicated to enabling all users to participate in the decentralized economy by offering an intuitive mobile wallet that powers trading, high-yield savings, NFTs, and other Web3 services. Crucially, this ultimate wallet does not hold user assets; users retain control of their private keys. But you also have the option to back them up to the cloud to protect them from accidental loss. At some point, these wallets will serve not only as a digital bank account but also as a digital passport, a browser, and a metaverse inventory.