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What is DeFI and Why Should You Care About It in 2023
DeFi is financial instruments in the form of services and applications based on blockchain technology. The main task of decentralized finance is to become an alternative to the banking sector and replace the traditional technologies of the current financial system with open-source protocols. That is, to give many people access to decentralized lending and new investment platforms and allow them to receive passive income from cryptocurrency assets and save on fees for transfers, loans, and deposits.
DeFi stands for decentralized finance, which uses a blockchain network to enable customers to access financial products and services without intermediaries such as central banks and bodies. DeFi was first launched on the Ethereum (ETH) blockchain, an open-source smart contract platform to facilitate the creation of decentralized applications. Ethereum provided the right platform for DeFi's success, and developers widely used the protocol as a robust platform for creating financial services to disrupt the traditional sector.
DeFi is emerging as a better alternative to traditional financials without intermediaries to offer a less trusted, cheaper, and more secure system for transferring monetary assets. The advantage of DeFi centers around the use of a blockchain network that provides the technical means for secure transactions (all transaction terms are spelled out in a smart contract) without a third (trusted) party. Secondly, DeFi offers the opportunity to go beyond financial transactions and create an innovative and dynamic world of real-life applications, including decentralized exchanges, stablecoins, lending and borrowing platforms, and farming.
DeFi is used to access blockchain-based financial services, meaning cryptocurrency owners can borrow, lend, earn interest, or trade-in perpetuity without needing a third party. While lending and borrowing are part of the functionality of decentralized financing, individuals can transact tokens through decentralized exchanges or DEX. The total market value of DeFi projects over its history in November 2021 showed an incredibly high value exceeding the $180 billion mark, an all-time high.
The Top 5 Most Promising DeFI Projects in 2023
Today, there are an incredible number of DeFi initiatives aimed at revolutionizing the field of decentralized finance, which is evolving at the same rate as other innovations based on distributed ledger technology. Let's take a look at the 5 most promising DeFi projects worth paying attention to in 2023.
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Compound
Compound Finance is a protocol that allows you to borrow and lend cryptocurrency assets without intermediaries. This is one of the most effective ways to circulate your investments, so they stay active in your wallet and the exchange. Any holder of a supported cryptocurrency can deposit it into a composite smart contract, where it will join the
When funds are deposited, the Compound protocol generates tokens called cTokens. These tokens can then be used as collateral for a loan, meaning the funds can be spent while they earn interest. Thus, if Ethereum (ETH) is deposited in Compound, then an equivalent amount of cETH will be received.
Compound's main smart contracts determine the amount of interest earned, which operates based on supply and demand. If many people want to borrow a specific asset, the smart contract increases the interest rate to attract lenders and make the loan more expensive. Compound currently supports nine assets issued on Ethereum, including Tether (USDT), Dai, Wrapped Bitcoin (WBTC), and Basic Attention Token (BAT).
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MakerDAO
It is an Ethereum-based smart contract platform that allows the issuance of DAI Stablecoin secured against cryptocurrencies and real assets. The platform is in first place among DeFi-protocols of the Ethereum ecosystem by the volume of locked liquidity (~$5.8 billion at the end of January 2023).
A key advantage of DAI is that it is not run by a private company but by MakerDAO, a decentralized autonomous organization over a software protocol. As a result, all token issuance and burning are managed and publicly recorded using Ethereum-based self-sufficient smart contracts, making the entire system more transparent and less susceptible to corruption.
One of the main uses of DAI is stable hedging - that is, insuring against risks from rate jumps of more popular crypto-assets like Ethereum or Bitcoin. DAI's stable price means the token is suitable for investors or traders who think the market is about to fall. Because DAI is stable, it is also one of the ideal
- Synthetix
Synthetix is an Ethereum-based derivatives liquidity protocol that allows synthetic assets to be issued and traded. Each synthetic asset (or Synth) is an ERC20 token that tracks the price of an external asset; for example, each sUSD token tracks the price of the US dollar and is fixed at 1. Synthetix has many synthetics, including fiat currencies, cryptocurrencies, commodities, and inverse indices. The system can support any asset with a clear price and provides chain access to an unlimited range of real assets. The protocol will provide many trading functions, including binary options, futures, and more.
Synthetix consists of a smart contract infrastructure and incentives that support synthetic asset prices. At the heart of this is the value of the Synthetix Network Token (SNX). SNX acts as collateral; The minting of any synthetic asset requires a proportional SNX value lock. Thus, the value of SNX is directly related to the use of the network it provides. To support the system, participants are rewarded with a proportional share of the commission fees arising from activities in the system.
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AAVE
AAVE is the largest decentralized money-market protocol, built on Ethereum and deployed in 6 different Tier 1 and Tier 2 networks. It allows users to deliver and borrow a wide range of crypto assets in a secure, permission-free environment.
Users are divided into borrowers and lenders. Lenders contribute assets to the liquidity pool and begin to earn interest proportional to the interest rate of the asset supply. For example, by providing USDT Stablecoin as liquidity, interest on it will also be charged in USDT. For a borrower to take the right asset from the liquidity pool, he needs to leave some assets as collateral. You should always leave more than the loan amount as collateral - this over-collateralization allows AAVE to remain solvent.
AAVE works by allowing users to supply assets and borrow against them. Users can contribute their cryptocurrency assets to the AAVE protocol, becoming a liquidity provider and receiving interest in exchange for providing funding. Borrowers can use their cryptocurrency assets as collateral, obtaining loans denominated in ETH or stablecoins such as USDC or DAI.
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Uniswap
Uniswap is a decentralized exchange (DEX) launched in 2018. Operations available on the exchange include cryptocurrency exchanges, currency collateral for
The platform is built on the Ethereum blockchain. There are over 170 tokens available on Uniswap. You can connect additional lists to the exchange and exchange almost six thousand coins. The exchange fee depends on the load on the Ethereum networks. Users place their funds in pools, providing liquidity on the exchange and getting rewarded for it.
The UNI token is the native cryptocurrency of the Uniswap decentralized exchange. It was launched in September 2020 and is used to manage the Uniswap protocol and power its various features. UNI token holders can participate in the platform's governance by voting on proposals to update or improve the Uniswap protocol. They can also earn rewards for providing liquidity to the Uniswap platform and use the token to pay transaction fees on the exchange.
How to Get Involved in The DeFI Ecosystem
The field of decentralized finance today brings together many areas of blockchain technology development, which can significantly simplify the processes of borrowing, lending, and transactions with various cryptocurrencies, tokens, and stablecoins, as well as using insurance services, issuing tokenized securities, and much more. To get involved in developing this promising area, you need to understand which of the many innovative areas you like best. Among the most popular are the following:
- Deposits & Loans (Lending Platforms)
In the traditional financial system, money is provided to borrowers by lending bodies. Lending protocols (or DeFi lending protocols) allow users to borrow cryptocurrency in decentralized finance (DeFi). DeFi protocols allow peer-to-peer (P2P) lending between network members. This eliminates the need for intermediaries.
The interest rates offered on such cryptocurrency platforms are much nicer compared to traditional banking bodies. The interest rate is usually influenced by different factors - what kind of cryptocurrency you hold, how much, and how long you're willing to lock it up for. Depending on the platform, the interest paid for holding cryptocurrency varies, but you can get up to 18% in some cases.
- Derivative Contracts/Synthetic Assets
Derivatives are special contracts whose value is determined by the value of underlying assets - cryptocurrencies, indices, stocks, commodities, bonds, etc. Derivatives are used by traders to hedge transaction risks.
Derivatives are now traded mainly on centralized platforms, but DeFi-platforms are already appearing for this purpose. They are protocols for synthetic assets that track the value of the underlying assets and allow access to them without purchasing them.
- Stablecoins
Stablecoins are cryptocurrencies whose exchange rate is always equal to fiat currency. They were created to mitigate the high volatility of digital currencies, which can reach 10% in a single day. One of the first centralized stablecoins was the U.S. dollar-linked Tether (USDT). It is trendy, and yet it has one major drawback - owners have to trust the company issuing the coins that dollar reserves in an appropriate amount actually exist.
The Future of DeFI and Where it's Headed
Open blockchains are transparent, and with no single supervisory authority over them, they offer a neutral, independent, and tamper-proof infrastructure for financial transactions. Software code is stored and executed in an open system. All data is publicly available and verifiable. This allows researchers and policymakers to analyze transactions, conduct empirical research, and calculate real-time risk indicators.
It's easy to envision a move to registries combining payments, tokenized assets, and financial protocols, such as those based on exchanges and credit markets. DeFi is an exemplary example of this trend, but similar changes should be expected in centralized infrastructure. This is because combinability within a single operation is only possible if all assets and financial protocols are in the same registry. In this case, there are powerful network effects. Neither crypto-assets nor central bank digital currencies would have much appeal if they were housed in a registry that did not include other assets or financial protocols. Creating a centralized infrastructure compatible with additional assets and financial protocols is possible. Still, it would be fraught with risk and governance issues due to the inherent characteristics of controlled registries. And this is a strong argument for decentralization, which is the future of DeFi.
All of this suggests that DeFi is designed to greatly simplify the interaction of various decentralized financial projects and institutions seeking to expand payment and lending opportunities not only for individual users, but also for businesses, which will greatly simplify, accelerate and optimize the transformation of the economic system.
Conclusion
The topic of decentralized finance covers numerous different elements, creating hundreds of successful applications in this area today. DeFi projects are also in demand in developed countries, as they offer a more profitable and affordable lending system and open up new opportunities for interest income from investments. At the same time, DeFi protocols in the future make it possible to create an independent infrastructure, reduce the risks inherent in classic financial structures, and can become an alternative to overly centralized solutions, which will help this technology take a strong place in the financial world of the future.