Are you someone who has only ventured into cryptocurrency recently? Next, you must have come across a category of crypto tokens known as DeFi, short for decentralized finance. But what does that mean? Let’s find out.
What is DeFi?
DeFi is a broad term that includes many different features and applications. Such applications do not involve any regulator or central bank or anyone for that matter and are completely decentralized and devoid of any control by a single entity.
“Decentralized finance or DeFi means the removal of any intermediary who acts or grants permission to conduct financial activities. The existing financial ecosystem falls under the category of centralized finance, including centralized banks such as the RBI (Reserve Bank of India) which decide the inputs around the repo rate. DeFi is a peer-to-peer financial service that only operates on a Blockchain platform with few or no middlemen, ”said Gaurav Dahake, CEO and co-founder of Bitbns.
What is DeFi Based Loan?
This is a rapidly growing segment of DeFi. Normally, when you buy crypto tokens and plan to hold them for a while, those coins are of no use in the meantime. By using DeFi lending protocols, you can put your crypto holdings to get a loan. These loans are easier to obtain and more affordable than those you take out from traditional banks.
For example, when you go to a bank to apply for a loan, the bank will check your credit history, perform a KYC (know your customer) process, and then review the value of the collateral, if applicable.
On the other hand, the lender and the borrower come together on a DeFi lending platform and execute smart contracts. The borrower gives their crypto as collateral and gets a loan from the platform, while the lender gives their fiat currency to the platform to earn interest.
“With decentralization in place and no middleman involved, it becomes easier for buyers, sellers, lenders and borrowers to interact with each other rather than with a company or institution facilitating a transaction. For example, if a farmer can sell their products directly to the end user without a middleman, their margins will improve dramatically and gain new access to a new community of buyers, ”says Dahake.
DeFi-based yield farming applications
This is one of the most promising use cases for DeFi. What is happening here is that users earn tokens by locking cryptocurrencies into smart contracts executed on the exchange’s trading platforms. These types of applications save the user time and money. This protocol essentially means that a crypto holder can search for more crypto tokens using the existing tokens.
There are many different strategies for doing this type of farming, but the most popular is where a platform like Yearn.Finance systematically moves the user’s tokens between a number of research loan platforms. a higher return on a blockchain like Ethereum.
“Yield farming enables the staking of crypto assets to generate high returns or rewards in the form of additional cryptocurrency. It prompts liquidity providers to stake or lock their crypto assets into a smart contract-based liquidity pool. These incentives can be a percentage of transaction fees, lender interest, etc. These returns are expressed as a percentage of annual return, ”explains Tarusha Mittal, member of the Blockchain and Crypto Assets Council (BACC) and COO and co-founder of UniFarm.
How do DeFi-based yield farming applications work?
Yield agriculture applications work with simple logic. Users lock in their holdings of crypto tokens and earn interest on them based on pre-existing smart contracts. It is similar to crypto token staking but the difference is in the mechanism of operation.
Yield farming works using several smart contracts and liquidity providers (LPs). LPs are users who are primarily in the system to provide money or liquidity to the smart contract system in return for a reward. The rewards earned by LPs can also be reinvested in other smart contracts. The Ethereum blockchain is the most popular underlying technology for these types of applications. The rewards that LPs get are also a type of ERC-20 token. ERC-20 is the proposal identification number in the list of official protocols for Ethereum blockchain network improvement proposals.
LPs provide funds in a liquidity pool. This pool is then used to create a marketplace where users using smart contract systems simply lend, borrow, or trade their crypto tokens by paying a fee. A portion of these fees is then given (in the report of funds provided) as a reward to the LPs.
“As in any other industry, there are both advantages and disadvantages; one of those risks is impermanent loss. In this context, the price of fixed assets in a liquidity pool changes after being deposited and creates an unrealized loss. Another risk is that of DeFi mat draws where DeFi developers create a new token and pair it with a leading cryptocurrency such as Tether or Ether and set up a liquidity pool. But always remember that like any other investment, it’s important to do your own research (DYOR) to avoid any risk, ”says Mittal.
What is the future of DeFi?
It’s surprising to know that DeFi, a new segment of the crypto ecosystem is worth billions of dollars. As of December 30, DeFi was worth $ 96.68 billion, the DeFi Pulse stapler showed. Coinmarketcap data showed DeFi-related crypto transactions were worth $ 15.45 billion on December 30. The amount of money stuck in DeFi is determined by the “Total Value Locked” metric.
Such a large amount of money flowing into the DeFi crypto ecosystem begs the question: what is its future potential?
“DeFi is all about code. Using smart contracts, your money is programmed to perform various functions. This creates a unique opportunity for anyone with a computer and an internet connection to participate in the global economy, ”said Sumit Ghosh, Blockchain and Crypto Assets Council (BACC) member and CEO and co-founder, Chingari.
Also, the DeFi sector is currently attracting a lot of funding. Recently, DeBank, a DeFi portfolio tracker that can currently track up to 17 channels, closed a $ 25 million fundraising round, at a valuation of $ 200 million, with investors including Sequoia China.
As with any new financial technology, DeFi also comes with certain risks. “There are various risks in DeFi because it is at an early stage of infrastructure development. The first is smart contract risk: technology can have bugs and you can lose your money. The second is market risk – the assets you lock in for the loan can depreciate to market value, ”says Santosh Yellajosula, member of the Blockchain and Crypto Assets Council (BACC) and head of the ecosystem, Xfinite, an ecosystem. entertainment center built on the Algorand blockchain. .