#1: Decentralised Finance is...
The future of finance in words, data and memes.
Recently, your LinkedIn and Twitter feeds must have lots of mention of DeFi or its cousin NFTs.
They deserve all the attention, really (but the hype is real too).
The DeFi space has grown by more than 40x (4,000%) in less than 1 year, now accounting for almost 5% of the whole crypto market.
The crypto land is buzzing with new projects almost every day - from SushiSwap to PancakeSwap and AmalaSwap (🤣) - it’s difficult to keep up to know what’s real and what’s not.
That’s why I started this newsletter - Decentralised - to help you get a good grasp of this very nascent financial technology space and keep you updated on the ongoing developments.
In this article, I’ll talk about just DeFi here. In the next newsletter, there would be a simple breakdown of NFTs.
What is DeFi?
DeFi stands for Decentralised Finance. It’s an attempt to bring core banking and Wall Street services onto the Blockchain.
As Bitcoin is to be a better store of value than the Dollar,
DeFi is to make savings, investing, lending, trading, and insurance services cheaper, efficient and scalable.
The main selling point of the Blockchain is the ability to transfer value to anyone, anywhere in the world within seconds at low transaction fees, without the need for a middleman like a bank. And not just that, users on the network can participate in decision-making rather than a single-entity telling everyone else what to do.
Let’s take an example:
A lending DeFi platform called Compound brings together crypto borrowers and lenders on its network.
Anyone can borrow cryptocurrencies directly from the network without having to negotiate loan tenure or interest rate with a third party. The borrower is only required to have enough funds in their crypto wallet to serve as collateral.
Also, anyone can lend their own cryptocurrencies on the network and earn higher interests than is obtainable in most traditional markets.
All these transactions don’t go through a bank or any middleman, it’s all executed by codes and algorithms on the Compound network within seconds. And everyone can see all these transactions - it’s an open database.
You might say you need to actually have cryptocurrencies to participate. Yes, for now. However, there are projects building beautiful interfaces and mobile apps that accept fiat currencies to onboard non-crypto users (the mass market). The conversion of your Dollar or Naira to cryptocurrencies is done on the backend for you.
Compound currently has more than $10 billion in assets on the platform.
Characteristics of DeFi
It is permissionless - there’s no sign up with email and name, there’s no ID required, and there’s no geographical restriction. Also, the code is open source.
It is trustless - there are no human intermediaries, just code and mathematics. This makes it available 24/7 and removes overhead labour costs.
It has a financial use case - the application solves an existing problem in the financial system, either in the credit markets, exchanges, asset management, or derivatives and prediction markets.
Decentralised Governance - the network is not controlled by a single entity, instead, allows users to participate in decision-making.
Non-custodial of assets - a single third-party doesn’t hold users’ assets.
Major Use Cases of DeFi
Lending and Borrowing
Users can borrow and lend their assets. The DeFi protocol allows users to deposit a variety of assets as collateral and borrow other cryptocurrencies against them including stablecoins.
If a borrower's collateral value drops below a specified loan-to-value ratio, their collateral will be sold to ensure the network stays solvent.
Examples of DeFi lending and borrowing platforms: Maker, Aave and Compound.
Decentralized Exchanges (DEX)
These are peer-to-peer marketplaces that allow people to directly trade cryptocurrencies with each other.
This should not be confused with the peer-to-peer platforms where users can transact directly with a known individual, like Paxful, Remitano and most of the other P2P platforms.
DEXes don’t offer custodial services (you can’t store assets on them). Also, there’s no geographical restrictions and limited asset option, unlike the regular P2P platforms.
Major Decentralized Exchanges: Uniswap, 1inch, Sushiswap, Curve, Kyber, Balancer.
Stablecoins
These assets are often pegged to fiat currencies such as the Dollar or Naira, other cryptocurrencies, or precious metals. The primary benefit of these assets is price stability because most cryptocurrencies are extremely volatile.
Notable stable coins: NGNT, DAI, USDT, USDC.
Asset Management
Don’t know how to invest in crypto assets? Some DeFi protocols allow users to earn passive income. They can help you manage your investment portfolio, set strategies and automatically rebalance to stay on your target portfolio allocations.
You can also save as an individual or as a group (cooperatives) on other protocols to earn higher yields than the traditional savings platforms.
Major examples include Xend Finance, TokenSets, and Enzyme Finance.
Other use cases are for insurance, prediction and derivative markets.
DeFi Risks
DeFi protocols are faced with quite a number of risks that could lead to loss of funds.
Hackers can steal people’s funds through social engineering, that is getting your secret phrase (similar to a password) and moving your funds from your wallet.
Hackers can also exploit flaws in a DeFi protocol codebase. DeFi platforms mitigate these risks by submitting their code to external, more experienced developers and security agencies to help detect and plug flaws.
Always lookout for the security agency that certified a DeFi protocol before using it. One of the most popular security firms is Certik. You can also see almost all DeFi platforms security ratings on there as well.
Be on the lookout for the governance structure of a DeFi platform. A structure that allows a single party to lock or transfer out funds without approval from multiple parties is a big risk. Reputable platforms like Compound prevent code changes or upgrades without the approval of multiple parties.
Other Useful Resources
https://thedefiant.io/top-10-defi-resources/
That’s all for Decentralised #1. In later issues, we’ll talk about the technical details, how to use DeFi platforms, Tokens and the role Ethereum and Binance are playing in this space.
Next Newsletter: #2
How is this Jack Dorsey (Twitter’s CEO)’s tweet worth $2.5million?
Find out in the next issue.
I’ll be breaking down NFTs and both of us would try to figure out whether it’s just a fad or not.
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