Decentralized Finance or DeFi is the movement that allows users to utilize financial services such as borrowing, lending and trading without the need to rely on centralized entities. These financial services are provided via Decentralized Applications (Dapps), in which a majority of them are deployed on the Ethereum platform.
DeFi is not a single product or company but instead, it is a set of products and services that acts as a replacement for institutions ranging from banking, insurance, bonds and monetary markets.
The idea of a decentralized application cannot be understood unless we begin with the smart contract. Smart contracts move value according to a set of predetermined parameters and rules. It comes down to the idea of programmable money. I think we’ll eventually see decentralized applications touch all kinds of industries. Right now, there are three particular areas where we see a lot of activities, and these are
- Open Financial Tools- Payments, credit and lending, Decentralized Exchanges, other DeFi Applications.
- Gaming and Digital Collectibles
Open Financial Tools
Although most developing countries have a functional payment system outside of the decentralized application, the picture is not so rosy when we consider it globally. 65% of the world’s population does not have access to payment systems. Even in areas where payment systems are accessible, they are often cost-prohibitive, so companies like Western Union charge north of 15% to move money across borders.
Studies have shown that digital transfer of value has several benefits. It can reduce crime, corruption, and the expense of moving money, increasing safety transparency and accountability. They also encourage responsible to adopt saving habits. With the decentralized application, a mobile phone with a connection, most developing countries jump-start traditional financial services and move directly into a universe of crypto-enabled payment. A cryptocurrency is being adopted as a means of payment, but the most popular example is Bitcoin.
Credit and Lending
Aside from payment, credit, and lending are areas that are starting to take off in the crypto space. These platforms enable fairer access to the credit landscape than we see today. The reason for that is that much of the space’s activity involves on-chain collateralization, making it easier to price risk and allowing more credit to be extended to the long tail of users who would otherwise be able to be serviced by banks or traditional lenders. One of the fascinating projects in this space is the makerDAO
Decentralized exchanges are one of the most important yet poorly understood areas of the decentralized financial landscapes. They allow peer-to-peer or, in some cases, peer to smart contract trading. This eliminates the risk for a centralized intermediary, which often carries many risks. Some of the most popular cryptocurrency exchanges are being hacked even some of the most prominent and well-run ones like Finance, which was hacked a few years ago. One of the potentials of decentralized exchanges is to avoid having a single point of failure minimizing hacks, and at the same time enable a more transparent trading environment where it is more difficult to manipulate the price or fake trading volumes as many centralized exchanges have done. One example of an interesting model of a decentralized exchange is Uniswap.
- Other decentralized applications include Hedging, Shorting, Derivative trading, and Prediction Market
Outside of the financial realm, we certainly see a lot of innovation in the infrastructure category. Central to that idea is the concept of a resource token. A resources token allocates scarce computing resources with real-world power. These scarce resources could be processing power, storage and memory, bandwidth, and various things. They have come down to an extension of the sharing economy. In the same way, Airbnb allowed you to share your physical space, uber and Lyft have allowed you a network of riders and drivers who communicate and collaborate. The same thing has been done with some of these digital resources.
Gaming and digital collectables
Gaming has led the way in technology development for many important past waves in technology. Anything from social, mobile, to the cloud, and now to the blockchain. Interestingly, blockchain-based games align incentives between participants in a way that has not been possible in gaming before. This comes down to eliminating some of the middlemen who sit between gamers and developers but instead passing that value back to the game creators and the game players. The most popular examples of blockchain games are Crypto kitties, Axie Infinity, Decentraland, and God’s Unchained.
Digital collectables catalyzed the idea of blockchain-based games. It is important to consider them as part of a broader trend of the physical world moving into the digital world. We’ll spend more time on our computers interacting in the digital space. The digital collectable world is a billion-dollar market.
At the core of how digital token works is the concept of Non-Fungible Tokens (NFTs). NFTs are interesting because they are uniquely scarce digital assets, and their identity can be confirmed on the blockchain. Because they are tracked on the blockchain, we can verify that there is only one, and you have it; nobody else does, which is very important in the collectible world. Crypto kitties were the first kind of digital collectible game that made the category mainstream.
Decentralized applications is a really wide area of discussion that brings to light how a lot of cryptocurrencies with use cases operate. This article only serves as a preliminary study in the wide world of DeFi!