In 2021, you may hear the word "DeFi" more and more. DeFi is short for Decentralized Finance. This is a type of application on the public chain that aims to create financial services that do not require a centralized intermediary. DeFi describes the vision that everyone can directly participate in peer-to-peer financial activities on a global scale. This vision requires long-term efforts, but it will eventually change the world.
However, DeFi is now considered to be a permissionless casino built on Ethereum. You may have heard people talk about their crazy gains on DeFi last year, heard of many projects that were successful only through plagiarism, and also heard of some dangerous contracts that explode, but you may still not know what DeFi is and how Start working on a DeFi project. Maybe you want to get a share of this new field, but you are not sure where the risks are. Very good, this short report is for you. I will treat you as a five-year-old, and explain what DeFi is in as simple and understandable words as possible. You are welcome to join this great western development.
What is DeFi
Bitcoin provides individuals with a non-sovereign digital value storage system with a fixed issuance limit, which in turn kicks off a decentralization revolution. However, only one asset cannot create a robust financial system. What users need are services and products that can invest and get returns. This is the role of DeFi. DeFi represents infrastructure that goes beyond traditional financial systems, such as lending platforms and exchanges.
DeFi also represents financial decentralization. What does it mean? DeFi is a broad term that refers to various financial applications that use cryptocurrency or blockchain technology to solve problems in the traditional financial system.
Today's financial system (consisting of banks, financial institutions, etc.) is mostly composed of centralized database systems, full of rent-seeking intermediaries, high handling fees, and hold-ups. With DeFi, a closed financial system can be transformed into an open financial economy based on open source protocols, which is more convenient, has fewer intermediaries, and is more transparent. Since these new financial protocols are implemented using smart contracts, they are both programmable and interoperable (because these protocols use similar technical standards during the construction process, they can easily communicate with each other).
DeFi and Ethereum
Today, most applications called DeFi exist in the form of code on the blockchain, mainly on Ethereum. Ethereum is an open source distributed computing platform based on blockchain technology, which can be used to build decentralized applications. Unlike Bitcoin, Ethereum not only supports simple native currency transfers, it can also easily build complex decentralized applications. Based on programmability and interoperability, new financial tools and assets that are more customized than existing financial products and services have been implemented on Ethereum.
Like many public chains, Ethereum is a digital ledger that allows many entities to hold copies of all their transaction history, which means that no single, centralized participant can control it. In the traditional financial system, DTCC (Depository Trust and Clearing Corporation) is the clearing center for financial securities (ie stocks, bonds, etc.). Ethereum is acting as a clearing center for tokens and smart contracts. At present, Ethereum can clear billions of transactions every day, but it does not need a centralized institution like DTCC to ensure the completion of transactions. This is important because a centralized system controlled by humans usually leads to excessively long transaction settlement delays, which reduces the user's ability to control funds while incurring higher fees.
Is DiFi useful?
DeFi applications are useful because they enable anyone in the world to obtain financial services provided on the public chain, which can eliminate intermediaries and lower user barriers to entry. Approximately 1.7 billion people in the world do not have a bank account, but two-thirds of these people have smartphones. DeFi allows users to obtain necessary financial services, including borrowing, saving and purchasing complex financial products, without requiring any permission or opening an account anywhere.
In developed countries, it is difficult for you to appreciate the importance of integrating into the financial system. A U.S. citizen can easily open a bank account, obtain a mortgage, or purchase stocks, bonds and other financial instruments that create wealth and preserve value as long as he walks into any JP Morgan Chase bank branch with an identity certificate issued by the government. However, imagine what would happen if your region, your gender, your education level, your government or some other uncontrollable conditions make you unable to obtain or only have very limited access to financial services. Such situations often hinder individuals and enterprises from obtaining original capital, because capital is unattainable. However, with DeFi, anyone can obtain these basic financial services needed for economic development.
What are the current DeFi application cases?
DeFi application cases include lending, spot trading, derivatives trading, stablecoins, asset management, predicting markets, and creating synthetic assets.
With the continuous development of the DeFi industry, Messari has developed a definition for decentralized financial assets. For a token to be part of "DeFi", it must meet the following requirements:
Financial use cases: The agreement must be clearly applied to financial scenarios, such as credit markets, token trading, issuance or trading of derivative/synthetic assets, asset management or prediction markets.
No permission required: The code is open source, allowing anyone to directly use or build new applications on its basis without going through a third party.
Use of pseudonyms: users do not need to reveal their true identity
Non-custodial: Assets are not managed by a single third party
Decentralized governance: Escalation decisions and management privileges are not controlled by a single entity, or (although this is the case for the time being,) there is at least one trusted path to remove these entities.
The following categories introduce these financial application scenarios and the corresponding existing applications.
The DeFi protocol can empower users to borrow assets. All current DeFi loans are over-collateralized, which means that users must provide collateral that exceeds the total value of their borrowed assets. This is like a mortgage, where individuals mortgage their homes to obtain loans. Using the DeFi protocol, users can mortgage various assets to borrow other cryptocurrency assets including stablecoins. When the ratio of the value of the borrower's collateral to the value of the borrowed item falls below the specified value, their collateral will be liquidated to ensure that the agreement remains solvency.
Well-known crypto lending platforms: Maker, Aave, Compound.
Decentralized exchange (DEX, Decentralized exchange) is a peer-to-peer trading market that allows any two parties to directly exchange cryptocurrencies. DEX aims to solve some of the problems inherent in centralized exchanges, such as centralized asset custody, geographic restrictions and asset selection restrictions. The most popular DEX currently uses an automated market maker system instead of a traditional order book system. Compared with the traditional matching buy and sell orders, in the automatic market maker system, users can deposit funds in a fund pool for trading, and determine the transaction price based on the ratio of the two assets in the pool. This DEX relies on users to provide liquidity, can make a market for any asset on Ethereum, and provide traders with always-available liquidity.
Famous decentralized exchanges: Uniswap, 1inch, Sushiswap, Curve, Kyber, 0x.
Stable currency is a cryptographic currency designed to maintain price stability with another asset. These tokens can be linked to legal currencies such as the US dollar, other cryptocurrencies or precious metals. The main benefit of these tokens is price stability, which may seem nonsense, but this is important because the prices of most cryptocurrencies are very volatile, which makes them difficult to use as general transaction equivalents. At present, the most popular stablecoins are anchored to the price of the US dollar. There are generally three ways to realize stablecoins: mortgage legal currency (the corresponding legal currency is stored in the bank account behind each stable currency issued), and mortgage cryptographic currency (every Behind the issued stablecoins, there is a corresponding cryptographic currency in the smart contract) and algorithms (behind each issued stablecoin is supported by an incentive system to ensure that the price is stable near its target price). In addition to price stability, stablecoins also provide a borderless payment system that is faster, cheaper and more secure than traditional payment networks such as SWIFT.
Famous stable currencies: DAI, USDT, USDC.
Synthetic assets are financial instruments that simulate the value of another asset. There are many ways to achieve value simulation, but generally, the input mechanism (oracle) of external price information is used to ensure that the price of the asset always closely follows the price of the target asset. The use of cryptographic assets can create infinite possible types of synthetic assets, and the existence of these assets on public chains such as Ethereum means that they can be opened to investors around the world. Before these assets were created, only a handful of people in the world could participate in the global financial market. The value that synthetic assets can provide investors includes: more diversified capital allocation, opportunities for hedging risks, and tools to increase investment returns.
Well-known synthetic asset platforms: Synthetix, UMA.
Financial derivatives-options, futures and perpetual contracts
The definition of financial derivatives in traditional finance is that a financial derivative is a financial contract whose value is derived from the performance of a certain subject matter. Such subject matter can be an asset, index or interest rate, which is often referred to as the "subject" for short. Although so far, compared with other DeFi agreements, such as lending, exchanges and stablecoins, financial derivatives have received limited attention, the transaction volume of the derivatives trading market will still increase tenfold in 2020. Platforms such as Synthetix, Yearn Finance and Hegic have helped financial derivatives get their name in DeFi.
Well-known options and futures trading platforms: Hegic, Opyn, Synthetix, Perpetual Protocol, Futureswap, Alpha Homora.
The prediction market is a platform for placing bets on the outcome of events such as games and elections. The market price reflects people's judgment on the probability of an event. The main difference between a decentralized prediction market and a centralized prediction market is that the former is built on a public chain, which means that no authority can control them. This makes these networks more flexible, safer, cheaper, more open, without hosting, and resistant to censorship. In addition to these, there are other advantages, including transaction costs tend to be the smallest, and eventually tend to zero over time; anyone can trade and create a prediction market for any event; participants do not need to deposit funds in the custodian; Decentralized prediction markets are more resistant to censorship and corruption. So far, the prediction market has received the least attention in the aforementioned DeFi agreements.
Famous decentralized prediction markets: Augur, Gnosis, Polymarket.
Why are organizations interested in DeFi?
2020 is considered to be the first year for institutions to start buying Bitcoin. In early 2021, CME launched Ethereum futures, which shows early signs that Ethereum will receive additional attention from institutions.
These signs may indicate that institutions are starting from Bitcoin and moving towards Ethereum, warming up for the eventual move to DeFi. It's not just me saying that, the digital asset development strategy expert group of the famous blockchain media The Block has also expressed similar views recently. In the panel discussion, the person in charge of Morgan Stanley's digital asset market said, "What I want to say is that the current momentum of the market's great interest in [DeFi] will continue until 2021." By 2022, some of the technologies that have emerged in the current stage of DeFi will definitely be used in a more standardized way." Although DeFi is still a fast-growing industry, these positive comments show that the market is maturing.
Perhaps just as important is that unlike Bitcoin and Ethereum, which are difficult to analyze with traditional financial models, many DeFi tokens can be considered capital assets, so traditional valuation methods can be used to analyze the value of these assets. value. Investors can construct discounted cash flow analysis, comparable company analysis, and comparable transaction analysis to evaluate the value of these assets. Based on a familiar analytical framework and unified valuation standards, DeFi assets will become increasingly attractive to financial institutions and investors.
DeFi trend forecast for 2021
For DeFi, 2021 will be an important year. As institutions get involved in Bitcoin in 2020, DeFi users have reached 1.2 million, and the industry is gaining momentum. Although the risk of interaction with DeFi is high, the operation is complicated, and user growth is limited because of this, these problems will continue to be resolved in 2021. As more and more capital, developers, and users join DeFi, there will be fewer and fewer obstacles to using decentralized financial protocols. We will have a more user-friendly interface on the DeFi aggregator and provide richer and easier-to-learn educational resources, which will attract users to participate in Defi more widely and bring exponential user growth.
Final thoughts on DeFi
Although these new financial agreements are experimental and have their own problems, DeFi has been building applications that can be implemented and is expected to achieve financial equality. Although institutions currently only study Bitcoin and Ethereum, they will eventually receive DeFi education and hope to build a more open and transparent financial system. A decentralized financial system will reduce costs and increase efficiency, but more importantly, it will provide financial services to millions of people who are currently unavailable.
Useful DeFi resources
Every DeFi analyst or investor relies on various tools to understand the latest developments in the DeFi ecosystem, assets, and the entire crypto market. Our team has provided every crypto market analyst with the most important tool.
For every DeFi analyst, investor or enthusiast, (without humility) we believe that Messari DeFi Screener is an essential tool for you. Based on our DeFi methodology, Screener will provide you with the most accurate information display of the DeFi ecosystem.