Rodrigo explains what DeFi is and the impact it will have on our financial reality.
With decentralized finance we enter a totally different financial world: a space where there are no intermediaries, such as banks.
DeFi, what you should know:
- The term DeFi comes from the acronym in English: Decentralized Finance; decentralized finance in Spanish.
- DeFi changes the paradigm of traditional finance, since it proposes a financial system without intermediaries or limitations.
- In the field of DeFi, smart contracts are essential to guarantee decentralization, automation, security and transparency.
- Some of the services that can be obtained with DeFi: swap (exchange of digital assets), staking, lending/borrowing and Yield Farming.
- Stable coins -stablecoins- are an option to enter the world of decentralized finance.
DeFi is the acronym for Decentralized Finance – decentralized finance in Spanish. In detail, DeFi services are financial products that run on a blockchain, such as Ethereum. These services eliminate financial intermediaries, such as traditional banks, and everything is automated through smart contracts.
When we talk about DeFi, we are referring to a set of tools, protocols, and platforms that provide services similar to those that we can find in the traditional financial system – a space where you can find benefits such as fixed-term payments or loans. The difference is that DeFi operates in a decentralized manner and offers greater privacy, security, opportunities, and transparency.
It is true: the characteristics indicated are similar to what -in essence- is a blockchain. However, in the case of DeFi, they adopt the same qualities and allow investment and lending systems to work in an automated, predictable and unalterable manner, since they are programmed with smart contracts.
The main benefit of DeFi is the fact that everything is managed without the need for intermediaries – such as banks, finance companies or agents. That is, the interaction only involves the user and the protocol, which makes it much easier and more accessible for people who have no background in traditional finance.
In essence, DeFi applications are DApps(Decentralized Applications; decentralized applications), since decentralized apps are computing tools that reside on the blockchain and use smart contracts to manage all the interactions that users have with the blockchain.
An example of a DeFi DApp: decentralized exchanges(DEX), such as Uniswap, which allow the automated exchange of crypto assets on a blockchain and without the need for intermediaries. When interacting with a DEX, you will notice that the transactions are straightforward and have simple and friendly interfaces. Of course, behind that, work Smart Contracts and security protocols that protect and secure user actions.
The different DeFi services refer to the same services offered by companies in the traditional financial sector, but with a substantial difference: everything is registered anonymously, although publicly, in the native DeFi protocol blockchain. Although we will not go into technical details, it is important to remember that everything generated on a blockchain is clearly verifiable, and without the need to compromise someone’s identity and privacy.
In addition, these financial systems, by using smart contracts in their development, allow token exchanges(swap), security deposits (known as staking) and money loans (give or receive one), to be carried out automatically., without involving people who slow down or deny these services (as mostly happens in traditional banking).
How Does The Traditional Financial System Work?
When you have money in a bank account, a person can access the capital at any time. You could also immobilize it with a fixed term and receive income for said deposit. The bank uses that deposited money to deliver it in loans (to clients or companies) and charges an interest rate.
However, only a part of that fee is given to the person who tied up your capital. The banking system calls this interest “award” or “benefit”, however, it is only a small part of the commission that the bank earns by operating with our money.
How Does The DeFi System Work?
DeFi protocols change the paradigm and the way of using financial tools. Decentralized finance protocols, such as Aave, allow you to earn a return on cryptocurrencies without losing control or ownership of the funds; In addition, they can be withdrawn when one decides, charging only what has been earned as commission up to that moment.
- Staking is one of the systems to use the tools that DeFi offers. It consists of keeping a certain amount of a cryptoactive that accepts this function blocked and receiving profits or rewards for it.
It is similar to “holding” (acquiring an asset and keeping it waiting for its value to increase), only in staking the balances are locked and cannot be freely used.
- Lending services, also called lending/borrowing services, are the most used in DeFi. They consist of lending or borrowing a certain amount of crypto assets. Lending involves lending your crypto assets to a liquidity pool, which would be a pool (swimming pool or pool, in other Latin American countries) where other users also contribute assets. The returns are obtained when the pool begins to “move”.
In such a context, “move” means someone needs to borrow those crypto assets, and they will only be able to withdraw them by offering collateral (usually an equivalent value in another cryptocurrency) and paying a fee. From this commission, the interest paid to the person who lent the cryptoactive is obtained – this taking of liquidity is called Borrowing.
- Yield Farming (yield agriculture, yield cultivation) is another service in these DApps, as well as another passive investment of the DeFi ecosystem that is quite similar to staking. Although there is a big difference between the two. In staking, crypto assets are locked for a certain time and, consequently, rewards are earned for it – in an investment that boasts of being long-term.
For its part, in Yield Farming the rewards are obtained by investing crypto assets in several platforms simultaneously. The objective: to try to achieve a greater amount of profits in a shorter time, but assuming a higher investment risk, since, due to the volatility of cryptocurrencies, this can lead to a total loss. Therefore, before investing in Yield Farming, it is necessary to carry out an investment strategy and investigate in depth – and that is something that we always reiterate in CryptoConnection: investments must be assumed with study, analysis and responsibility.
Defi With Stablecoins
Stablecoins are a type of crypto asset that pegs its price, at a 1:1 (one to one) parity, to another asset. The most commonly used stablecoins are those that are pegged to the US dollar (USD).
Stablecoins feed the DeFi ecosystem for the most part, since they have very low volatility (almost zero), when compared to options such as bitcoin or ether. This implies that operating with them is safer and more predictable.
Although the crypto ecosystem has caused a revolution in terms of the monetary and financial system -because it has given the user full control of their funds, without the need to depend on banks, governments or intermediaries-, we must also take into account He realizes that volatility is one of the characteristics of the crypto market, and a factor that still drives people away from the industry – in fear of losing all their resources.
In this sense, stablecoins, given their lower volatility, contribute to the adoption of the crypto ecosystem in an easier, safer and faster way. Tether(specifically USDT, its USD-pegged version), USD Coin(USDC) and DAI are the most recognized stablecoins in the industry.
Entering DeFi with stablecoins offers several advantages, among others: its value is fixed around the USD(a key currency in global markets); there is no purchase limit regulated by government decisions; and allows value to be protected against inflation and the devaluation of the local currencies of countries with economic problems. They can also be deposited in DeFi for long-term returns in crypto without the need for bank accounts, plus they are easy to store and transfer at any time.’
Advantages And Disadvantages Of Decentralized Finance
Like any technology that emerges in the world, around DeFi there are advantages and disadvantages. Here we review these aspects:
- They allow you to take loans, exchange crypto assets and generate returns in a safe, private and transparent way.
- By working with smart contracts, it is not necessary to cede control of assets to any bank or centralized entity.
- Intermediaries are eliminated and, consequently, they offer a higher return than that of the traditional financial system; They also lower costs and commissions.
- Smart Contracts allow agreements to be predictable and inviolable.
- DeFi financial markets never close.
- The technology is safe, but it is not immune to fraudsters, since the freedom in asset management is much more latent than in traditional services.
- If a Smart Contract fails, the entire DApp would also fail, as it already happened with The DAO.
- Given the volatility of the crypto asset market, DeFi protocols are still inefficient.
The DeFi market
DeFi services have found, as seen in this graph, a good response among consumers.
Monthly revenue from top DeFi providers.
What are DeFi
Defi Investments With A Latin American Flavor
The Latin American area of the decentralized economy continues to attract investors -investments in the sector went from $68 million dollars (USD) in 2020 to $658 million USD in 2021.
And the DeFi space is one of the ones that arouses the most interest, as you can see in this list, which highlights the financing rounds that took place in Latin America between the first and third quarters of 2022.
- (Company / Country / sector or activity)
- Credix / Brazil / DeFi
- Koibanx / Argentina / Tokenization of assets
- Fluyez / Peru / DeFi
- Digitra / Brazil / Exchange
- Belo / Argentina / crypto portfolio
- SenseiNode / Argentina / Blockchain infrastructure
- Let´sBit / Argentina / DeFi
- Lithium / Colombia / DeFi
- Foxbit / Brazil / Exchange
- Delt.ai / Mexico / DeFi
- Moss.earth / Brazil / Blockchain infrastructure
- 2TM / Brazil / Payments in blockchain infrastructure Tribal Credit / Mexico / Payments in Fintech infrastructure
DeFi is changing our idea of financial services. However, decentralized technology is revolutionizing many more aspects of our reality. Would you like to understand the vision and the technological pillars that drive this transformation?