Decentralized finance, or DeFi, is touted as the future of personal finance, offering users a trustless peer-to-peer system to buy and sell digital assets. However, it’s also a term that is often misused, or there is a misconception that it represents a single specific function that centers solely around buying cryptocurrencies.
DeFi is an umbrella term that encompasses a wide range of products and sub-sectors. In this article, we’ll detail six of the most prominent macro categories in DeFi to give you a general but concise understanding of the distinct protocols, financial services, and tools they provide.
DeFi asset management services seek to make investing simpler, cost-effective, and more accessible. Because these systems are non-custodial, users are not required to reveal their private keys or transfer funds. Furthermore, these services are automated, allowing seamless and speedy rebalances, collateralization, and liquidation. Crypto wallets such as MetaMask, Gnosis Safe, and Argent enable you to securely engage with decentralized apps to accomplish anything from buying and selling digital assets to staking tokens to earn an annual percentage yield (APY).
DeFi asset management also offers enhanced transparency since it is based on decentralized technology. Transparency is a complex component in conventional finance: transaction settlements may take days or sometimes weeks, and corporations have been known to fudge numbers or keep investors in the dark about their fiscal obligations. On the other hand, blockchain technology makes transaction records readily available at any moment, so investors can see where funds are being transferred and base their investment decisions on fully transparent transaction histories.
Most individuals who invest in cryptocurrency for the first time are advised to “hold on for dear life,” or HODL, and wait for their assets to appreciate before selling. But if you’re inclined to take on a more aggressive approach to investing in crypto, keeping your tokens tucked away in your wallet probably isn’t the best way to achieve your goal. This is where crypto lending and borrowing could provide you with an avenue to grow your digital currency stack. Please note this is not financial advice — but rather an insight into one type of DeFi tool some investors leverage.
As the name suggests, crypto lending and borrowing involve investors lending their crypto to various borrowers who wish to participate in the market but don’t want to liquidate their current holdings to do so. In return, lenders receive interest payments, often known as “crypto dividends.”
For example, let’s suppose an investor is holding 100 TLOS, but also requires capital to execute another trade. The investor doesn’t want to liquidate their TLOS — and we tip our hats to them — but can use it as collateral to borrow capital from a lender. These peer-to-peer protocols have grown tremendously popular over the years and are now some of the most commonly used applications in all of DeFi.
There are, however, several caveats one should be aware of before seeking out a crypto loan. For example, unlike borrowing from a traditional institution that would typically require 80% of the loan value as collateral, a crypto loan typically requires borrowers to provide upwards of 200% of the loan value (or more). Additionally, borrowers may be required to stake some of their tokens to offer lenders further assurances that they can recoup any losses in the event of a liquidation.
Peer-to-peer payment is undoubtedly the cornerstone of DeFi and the blockchain ecosystem as a whole. This function of DeFi technology is designed to allow users to trade cryptocurrencies safely and directly with one another, eliminating the need for intermediaries. DeFi payment systems are helping big financial institutions optimize market infrastructure and better serve their clients while establishing a more open economic system for users in underbanked and unbanked communities.
DEXs are cryptocurrency exchanges that enable users to conduct peer-to-peer transactions and fully control their assets. DEXs rely on smart contracts to execute user transactions meaning they have no central authority monitoring their operations. Furthermore, because crypto assets are never in the custody of the exchange itself, the danger of price manipulation, hacking, and theft is significantly reduced. Privacy is also a topic of interest when discussing DEXs since users of these exchanges can remain completely anonymous.
DEXs inject a healthy dose of competition into the market as they provide many token projects with much-needed liquidity that centralized exchanges sometimes cannot match — and without costly listing fees. Some of the more popular DEXs in the DeFi space include Uniswap, PancakeSwap, SushiSwap, Raydium, ApeSwap, 1inch, and Curve.
In the same way, conventional derivatives operate, a buyer and a seller engage in a contract to sell an underlying crypto asset. These assets are then sold at an agreed-upon time and price. As a result, crypto derivatives lack intrinsic value and derive their value from the underlying asset’s value (hence the name). An Ethereum derivative, for example, is dependent on and derives value from the value of Ethereum. It’s important to note that investors who opt to trade derivatives are not holders or owners of the underlying asset. Futures, options, and perpetual contracts are the most common crypto derivatives.
Any cryptocurrency tied to a stable asset, such as fiat, gold, or other cryptocurrencies, is referred to as a stablecoin. These digital assets were created to minimize the volatility of cryptocurrency values and make blockchains a viable payment alternative. For example, tokens such as USDT, USDC, and BUSD are pegged to the US dollar, while tokens like PAXG are pegged to the price of gold. Today, stablecoin use cases include remittance payments and collateral for lending and borrowing platforms, and they have even found their way into government institutions via central bank digital currency (CBDC).
We hope you enjoyed this overview of some of the more prominent macro categories that make up decentralized finance. As part of our Telos Fuel Liquidity Incentive Program, we’re integrating many of these tools into our own DeFi ecosystem to access new market share and foster unprecedented levels of growth. Read more about our multi-phase initiative here.
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