The Different Types of DeFi Services You Can Leverage in Your Daily Life
How to make money with DeFi without risking panic attacks.
Table of contents:
1. Our current centralized financial system.
2. Introduction to DeFi.
3. What problems does DeFi solve, and why should you care?
4. Introduction to DeFi applications
- Stablecoins
- Wallets
- Yield farming
- Liquidity mining
- Staking
- Trading
- Borrowing, lending, saving
- Derivatives
5. Conclusion/ TL;DR
Every single day of your life, you’re using financial services.
To be exact, centralized financial services.
In the world we live in today, our financial system (and all its services) are completely centralized. Insurance companies, banks, and financial institutions all have people in charge.
And with that come the natural risks of involving petty old, emotion-driven human beings in anything — at some point, at some level, you’ll experience mismanagement, fraud, corruption, discrimination, or worse.
But what if we could decentralize our entire financial system (by making it transparent and trustless) in the same way that Bitcoin decentralizes money?
Bitcoin is a cryptocurrency that allows money to be transferred anywhere between anyone without a third party. A decentralized network of computers (or users) agrees through a consensus mechanism that a specific ledger of transactions is correct.
Transferring money is one of the fundamental building blocks of our current financial system. However, there are many services people use that include savings plans, stock markets, insurance, loans, and other services in their day-to-day life.
They’re all built around money, and they make up the entirety of our financial system.
“Decentralizing” these financial services means they would operate without a central authority or someone in charge.
By using decentralized money, such as certain cryptocurrencies, we can build insurance companies, decentralized exchanges, lending platforms, and other services that are not controlled by a central entity.
That’s what DeFi is all about.
What is DeFi?
Let’s give this broad term a more straightforward definition.
The term DeFi itself is a collective term for the peer-to-peer financial services and applications on public blockchains. (Most often Ethereum.)
To create a decentralized financial system, the first thing you need is an infrastructure that would allow you to run and program decentralized services.
Ethereum does exactly that.
Ethereum is a do-it-yourself platform for writing decentralized applications.
Through the use of the Ethereum platform, you can write automated code (also known as a smart contract) that manages any financial service you want to create.
(While you can create DeFi applications on other blockchains, Ethereum is the most popular and accessible choice for people in 2022.)
This means that, by definition, DeFi can encompass any system that completes traditional financial transactions without any use or interference from an intermediary.
You can determine how the rules of the service will work, and once you initially deploy these rules on the platform, you no longer have control over them — they are immutable and decentralized.
The fact that cryptocurrencies are decentralized has always been one of their unique selling points, but it was only after the launch of Ethereum that more advanced decentralized applications became prevalent.
Those applications laid the foundation of the current DeFi system.
What problems does DeFi solve, and why should you care?
One of the best ways to realize the potential of decentralized finance is to explore the problems that it aims to solve.
What are some problems you might run into dealing with traditional centralized financial institutions?
× Financial services companies can block you from getting paid.
× Financial services include the hidden charge of giving out your personal data.
× There are more than 1.7 billion unbanked adults in the world. (Source)
× Some people cannot be granted access to set up a bank account or use financial services.
× Trading hours can sometimes be limited to the specific business hours of a time zone.
× Some money transfers can take days due to various internal human processes.
× Governments and other centralized institutions can close down markets as they please.
× Lack of available financial services at a local level can prevent people from being employable.
DeFi applications aim to solve these problems and provide alternatives to human-dependent processes by making our financial system transparent, trustless, and decentralized.
We’ll explore specific use cases, or DeFi applications, below.
What are DeFi applications?
The current DeFi landscape today already includes countless different financial applications, and it’s showing no signs of slowing down. After all, there is no limit to what a DeFi application could accomplish if the smart contract is crafted well enough.
Today, we’re going to explore the most important decentralized services and applications that make up the DeFi space today.
They include:
- Stablecoins
2. Wallets
3. Liquidity, mining, and staking
4. Trading/exchanges
5. Borrowing, lending, and saving
6. Derivatives (trading)
(DeFi applications can include anything from alternative savings, asset management tools, DAOs, derivatives, decentralized exchanges, insurance, KYC and identity, lending and borrowing, margin trading, stablecoins, staking, tokenization of assets, marketplaces, yield aggregators, and countless more. But today, we’re focusing on just the six biggest, most essential categories.)
Let’s start with number one.
#1 STABLECOINS
Stablecoins are cryptocurrencies whose value is fixed against a fiat currency or an underlying asset.
Because their value is fixed against an asset, the value of the stablecoin is likely not going to drop below the value of the asset it is tied to.
Their role in DeFi is essential — they enable investors to generate yield on their crypto assets while alleviating a lot of the volatility and all of its adverse effects.
Stablecoins are the best solution we have so far for the volatility the current DeFi ecosystem has created. They allow you to transfer funds quickly and circumvent financial service fees. They allow the entire market to experience fewer price fluctuations.
Stablecoins are needed throughout other decentralized financial services, as you will learn below.
#2 WALLETS
A big part of all crypto transactions still falls under the definition of “centralized” because the average crypto exchange is centralized and uses a third party to facilitate transactions.
On some centralized exchanges, where a big part of people hold their cryptocurrency holdings, the private keys to your wallet are not your property.
That’s why you should be advised to store your cryptocurrency holdings inside hard wallets (which are physical wallets.)
Or, at the very least, use a non-custodial wallet.
DeFi wallets such as the MetaMask Wallet are examples of non-custodial wallets. This means you retain possession of your crypto, and you are solely responsible for the private keys that grant you access to your wallet.
#3 YIELD FARMING
Yield farming refers to placing your crypto assets inside a DeFi protocol with the purpose of generating the highest returns possible.
Yield farming can take countless forms, but the most common form you’ll find is depositing funds in a high-yield lending protocol.
Two examples of the convergence of fintech and crypto are Dharma and Compound, where applications can enable innovative financial services.
#4 LIQUIDITY MINING
DeFi mining, also known as liquidity mining, involves pairing your digital assets (whether they’re coins or tokens) such as ETH or DAI and storing them inside what’s called a liquidity pool.
Liquidity pools allow other DeFi users to have the constant liquidity they need to facilitate trades between two parties.
You will receive a return on your investment, and all the while, you’ll be helping other platform users have the liquidity they need at all times.
#5 STAKING
In simple terms, staking involves holding certain funds inside your cryptocurrency wallet with the purpose of supporting the security and operations of a blockchain.
Staking is a way that users can participate in the consensus algorithm of a proof-of-stake ecosystem, exactly how miners would create new blocks in a proof-of-work mechanism.
Both would be ways to validate a blockchain, but staking assigns a certain mining power based on a user’s ownership stake (or the percentage of a coin the user owns.) This requires far less computational energy than proof-of-work.
#6 TRADING
DeFi trading applications will let users engage in crypto investments without the use of a centralized exchange.
That’s how decentralized exchanges (or DEXes) came to be.
Decentralized exchanges operate by following a set of smart contracts enabling users to buy and sell crypto. They reside inside the Ethereum platform and operate without any central governance.
When you trade on the DEX, there’s no required identity verification, no signups, no withdrawal fees. Instead, smart contracts enforce all the rules, execute the trades, and securely handle your funds.
And there’s often no need to deposit funds inside your account before engaging in a trade, meaning you don’t hold a balance on the exchange.
Currently, much of cryptocurrency trading is centralized, just like the trading of stocks. Coinbase, Binance, and Kraken are some of the biggest, safest, most secure centralized exchanges.
On the other hand, decentralized exchanges such as Uniswap and PancakeSwap rely solely on smart-contract and blockchain technology to execute trades, and they let users buy and sell with each other directly.
#7 BORROWING, LENDING, AND SAVING
DeFi savings accounts are similar to traditional savings accounts but provide you with much higher interest rates. You can watch your interest stack up in real-time, but platforms usually send daily, weekly, or monthly payouts.
Smart contracts can also be built to let you borrow and lend your cryptocurrencies without the use of an intermediary. This eliminates a lot of the risk involved in traditional lending.
Here’s one example — if a borrower fails to meet their obligations in a flash loan, the lender can instantly take the funds back. Therefore, in most DeFi lending situations, some form of collateral is necessary.
Decentralized money markets are services that connect borrowers with lenders.
One such service is Compound — an Ethereum-based borrowing and lending dApp that gives users the ability to lend out their crypto and earn interest on it.
Compound automatically connects lenders to borrowers, enforces the terms of the loans on both sides, distributes the interest, and it’s this process of earning interest on crypto that has given rise to the popularity of yield farming (aiming to generate the highest returns possible.)
#8 DERIVATIVES
If you were to go on any cryptocurrency exchange right now and buy a certain amount of a cryptocurrency at a specific price, that’s a spot trade.
Unlike spot trades, derivatives trades do not directly involve the cryptocurrency (or asset.) Instead, they take the role of a financial contract based on the speculated future value of the asset.
This perceived difference between an asset’s current value and future value provides the market with opportunities to liquidate, hedge, and arbitrage.
This means either massive potential wins or crippling potential losses.
Derivatives are one of the fundamental components of the crypto economy for three reasons:
First, they promote price discovery. Price discovery is a fancy term for determining the price of an asset.
Second, they’re useful for investors in that they can help you safeguard your portfolio against extreme volatility in price or unexpected factors and risks. Derivatives allow you to “short” an asset, meaning you can actually bet against the price if you want to. Think about it — without a derivatives market, how much more limited would the options be for long-term investors to protect their assets in a bear market?
And the third reason, which builds on the second, is that derivatives allow investors to create more sophisticated strategies such as arbitrage trading or pairing so they can manage risk better.
If you want to learn how to trade derivatives without losing all your money or becoming a degenerate derivatives gambler (they exist), there are several blogs you can read (such as Binance Academy) or courses you can take online. But one thing’s for sure: derivatives are for experienced investors who know what they’re doing.
Conclusion: Is DeFi really the future of finance?
Stablecoins, decentralized exchanges, money markets, lenders, insurance, all of these new and innovative financial products come with a ton of risks, but they’re working on that.
The most important risk is that DeFi is in its infancy. Things can go wrong. And they will. Smart contracts have always had issues in which hackers find creative ways to exploit the loopholes in the code to reap financial gain.
A system is only as decentralized as its most central component.
Some financial services might only be partially decentralized while still keeping centralized aspects that can act as an Achilles heel.
Always make sure you 100 percent understand what you’re investing in before you jump into the latest and greatest trend in the DeFi space.
The DeFi revolution is reaching its early adoption stage.
We’ll see if it can breach the chasm into mainstream adoption.
There’s no doubt that a decentralized financial system can improve the lives of the population currently suffering from inefficiencies, financial discrimination, and high fees.
And while everything happens autonomously without an agent in the middle, and DeFi services having the ability to work in conjunction with another, we have an exciting future ahead as we mix and match different services to build a new, decentralized, trustless financial system.
TL;DR
- Decentralized financial services are built on blockchain technology, removing the need for a third party to settle transactions.
- Decentralized financial services include applications (smart contracts) built on different blockchains, that can include stablecoins, borrowers and lenders, decentralized exchanges, derivatives trading, yield farming, staking, and so much more.
- Through the adoption of these new decentralized financial services, a new trustless financial system can be built that leaves the old ways behind and gives you power over your data, funds, and privacy.
