Decentralized financial services
DeFi is the hottest topic discussed by the cryptocurrency enthusiast community in 2020. Let's try to understand why the DeFi ecosystem has become so popular this year. DeFi, also known as decentralized finance, is fundamentally different from traditional banking services. Cryptocurrencies can eliminate intermediaries such as financial institutions, and transferring digital assets between wallets is cheaper and faster than using a bank transfer.
Additionally, DeFi (decentralized finance) is an option for people who do not have access to banking services. All they need to participate in the DeFi ecosystem is to have a smartphone with internet access. The source code of DeFi projects is transparent and open to audit. This eliminates the risk of possible bank failures. However, this does not turn the DeFi ecosystem into a money printing machine, and there are risks in this area too. Below we look at the risks in more detail.
There are different use cases for DeFi:
- Lending and borrowing
- Exchanges
- Stablecoins< /li>
- Derivatives
- Portfolio management
- Lotteries
- Payments
- Insurance
In general, in 2020 we can already talk about the existence of a decentralized ecosystem, completely independent of authorities and regulators. This is both the strength and weakness of decentralized finance. For example, on Uniswap and other decentralized exchanges, duplicate tokens are often listed, when the name of such a token is identical to the name of an already known cryptocurrency. There are also several reported cases of money laundering through Uniswap as a result of hacking and other illegal activities.
How DeFi works: an inside look
Almost all modern decentralized ecosystems operate on the basis of Ethereum and “smart contracts”. Decentralized exchanges require locked cryptocurrency. If at the beginning of 2019 the total amount of such blocking was $275 million, then by August 30, 2020, the total value of cryptocurrency blocked in DeFi was $8 billion. At the same time, the increase in the total blocked value in August 2020 was 85%. By September 28, the total amount of cryptocurrency blocked reached $11 billion.
The Ethereum Virtual Machine allows you to execute “smart contracts”. A fee called gas is charged for fulfilling the contract. The amount of this fee is floating, it depends on the load on the Ethereum network. The interface of a decentralized application is the same as for a regular web application or mobile application. However, internally they rely on the Ethereum blockchain. A decentralized ledger can also be used to verify that user data has not changed.
Recently, this type of earning on cryptocurrency has become popular, such as staking (liquidity mining). It is entirely based on smart contracts. The liquidity pool is filled with Ethereum. It serves as a reserve for decentralized exchange. The presence of funds in the liquidity pool does not impose obligations to maintain the functionality of the blockchain and does not give the right to manage the further development of the project. The liquidity pool is connected to the blockchain using smart contracts. These contracts both lock funds and reward the owner of the liquidity pool. This reward is paid in tokens, which can go up or down in value. Some users have managed to build profitable chains in which the tokens they receive serve as collateral for other tokens.
The most famous DeFi projects
The Uniswap project received positive attention and early funding from Ethereum founder Vitaly Buterin. Now Uniswap confidently ranks first among Ethereum projects in terms of commission costs. The daily trading volume here is more than $500 million, which is more than the Coinbase Pro or Kraken exchanges. You don't even need to register to make transactions. There is no account, and to start working with it, just enable the wallet program MetaMask. The project uses its own UNI token, which is listed on many major exchanges. In just one day, the UNI token rose from 203rd to 26th place in popularity among all cryptocurrencies. Ethereum miners have earned more than $1 million in these days, significantly increasing commissions on the network. More than 100,000 users received a gift from Uniswap: UNI tokens worth about $1,000. One Uniswap user received $400,000 worth of UNI tokens, while five users received $250,000 worth of tokens. The amount of remuneration for project participants depended on the amount in the liquidity pool that they managed to secure on the platform.
SushiSwap has become a clone and closest competitor of Uniswap. Almost immediately, a couple of weeks after the launch, the Sushi project began to generate a profit of 1,500% per annum. And all project participants began to receive Sushi as passive income. Three weeks after the launch of Sushiswap, the amount of locked funds in the project's liquidity pool reached $1 billion. And this despite the withdrawal of $14 million, which was made on September 5 by the anonymous founder of the project, calling himself a “chef.” His antics attracted the attention of the FBI and the US Internal Affairs Service. As a result, part of the funds was returned to the exchange.
Yearn.finance is an automated program for making money in a liquidity pool. Users just need to indicate the name of their tokens for the system to select several potentially profitable pharming options (liquidity mining). Yearn.finance also chooses ways to obtain rare tokens that require a multi-step cryptocurrency exchange. Yearn.finance provides background information on which cryptocurrencies allow you to earn income by saving or borrowing. The internal YFI token allows people to vote on the future path of the project. In the summer of 2020, its cost did not exceed $3. YFI then steadily rose in price, peaking at over $40,000 (September 2020). Since then, YFI's price has declined. However, the YFI token is still one of the most popular tokens on decentralized exchanges.
Further prospects for the development of DeFi
An important advantage of DeFi applications is independence from third-party influence. In addition, it removes boundaries and operates without a central authority, allowing you to fully control your capital.
The downside of DeFi is that smart contracts can have bugs and that programs can be hacked. One of these hacks previously led to the theft of the equivalent of about $50 million from the decentralized DAO fund and, as a result, to the division of the Ethereum blockchain. Also, decentralized applications have scalability issues. So far, DeFi relies almost entirely on the Ethereum Virtual Machine. If DeFi's popularity grows, it will become even more entrenched in the technical limitations of the Ethereum network.
