Decentralized applications that provide financial services on a blockchain and are known as DeFi.
Decentralized Finance aims to create borderless, censorship-resistant and accessible financial products for all.
These can be centralized, semi-decentralized or decentralized. One of the keys of most DeFi projects is to have little to no intermediaries.
Here we will provide an overview of the top DeFi applications and categories and the most popular coins/projects that fall into one of these top DeFi categories/types.
This post for sure is good for beginners and give you a good start into the DeFi rabbit hole.
The prices of cryptocurrencies are known to be highly volatile. It is common for cryptocurrencies to have intraday swings of over 10%. To mitigate this volatility, stablecoins that are pegged to other stableassets such as the USD were created. There are 3 types of stablecoins: backed by Fiat (i.e.Tether, USDC), backed by Crypto (i.e. Dai) and Algorithmic stablecoins.
The latter comes in two forms, Seigniorage-model (i.e. Empty Set Dollar) and rebase (i.e. Ampleforth). It is beyond the scope of this post to get into detail about this.
Tether (USDT) was one of the first centralized stablecoins to be introduced. Every USDT is supposedly backed by $1 in the issuer’s bank account. However, one major downside to USDT is that users need to trust that the USD reserves are fully collateralized and actually exist.
Decentralized stablecoins aim to solve this trust issue. They are created via an over-collateralization method, operate fully on decentralized ledgers, and are governed by decentralized autonomous organizations. Anyone can publicly audit their reserves.
While stablecoins are not financial applications themselves, they are essential in making DeFi applications more accessible to everyone by having a stable store of value.
2. Lending and Borrowing
Traditional financial systems require users to have bank accounts to utilize their services, a luxury that 1.7 billion people currently do not have. Borrowing from banks comes with other restrictions, such as having a good credit score and having sufficient collateral to convince the banks that one is credit-worthy and able to repay a loan.
Decentralized lending and borrowing remove this barrier, allowing anyone to collateralize their digital assets and use this to obtain loans. One can also earn a yield on their assets and participate in the lending market by contributing to lending pools and earning interest on these assets. With decentralized lending and borrowing, there is no need for a bank account nor checking for credit-worthiness.
Compound is an example of a decentralized lending and borrowing protocol on the Ethereumn blockchain. It is an open-source money market protocol where anyone can lend or borrow cryptocurrencies frictionlessly. In essence, Compound bridges the gaps between lenders who wish to receive interest from funds they do not currently use and borrwers who want to borrow funds for productive or investment use. An even more popular one is Aave.
To exchange one cryptocurrency for another, one can use exchanges such as Coinbase or Binance. Exchanges like these are centralized exchanges, meaning they are both the intermediaries and custodians of the traded assets. Users of these exchanges do not have complete control of their assets, putting their assets at risk if the exchanges get hacked and are unable to repay their obligations.
Decentralized exchanges aim to solve this issue by allowing users to exchange cryptocurrencies without giving up custody of their coins. By not storing any funds on centralized exchanges, users do not need to trust the exchanges to stay solvent. The two most popular examples of DEXs are Uniswap on the Ethereum blockchain and PancakeSwap on the Binance blockchain.
A derivative is a contract whose value is derived from another underlying asset such as stocks, commodities, currencies, indexes, bonds, or interest rates.
Traders can use derivatives to hedge their positions and decrease their risk in any particular trade. For example, imagine you are a glove manufacturer and want to hedge yourself from an unexpected increase in rubber price. You can buy a futures contract from your supplier to deliver a specific amount of rubber at a specific future delivery date at an agreed price today.
Derivatives contracts are mainly traded on centralized platforms. DeFi platforms are starting to build decentralized derivatives markets. Examples of DeFi Derivatives platforms are Synthetix and Uma. Another worthy mention is Opyn. It’s a platform that makes use of financial derivatives (mainly options) to get protection against price volatility of your assets.
5. Fund Management
Fund management is the process of overseeing your assets and managing its cash flow to generate a return on your investments. There are two main types of fund management – active and passive fund management. Active fund management has a management team making investment decisions to beat a particular benchmark, such as the S&P 500. Passive fund management does not have a management team but is designed in such a way to mimic the performance of a particular benchmark as closely as possible.
In DeFi, some projects have started to allow passive fund management to occur in a decentralized manner. The transparency of DeFi makes it easy for users to track how their funds are being managed and understand the cost they will be paying.
TokenSets is a platform that allows crypto users to buy Strategy Enabled Tokens (SET). These tokens have automated asset management strategies that will enable you to easily manage your cryptocurrency portfolio without executing the trading strategy manually.
As DeFi continues to evolve, creative and disruptive financial applications will emerge, democratizing accessibility and removing intermediaries. Putting a DeFi spin onto lotteries allows for the removal of custodianship of the pooled capital into a smart contract on the Ethereum Blockchain.
With the modularity of DeFi, it is possible to link a simple lottery Dapp to another DeFi Dapp and create more value. DeFi Dapp PoolTogether allows participants to pool their capital together. The pooled money is then invested into a DeFi lending Dapp and the interest earned is given to a random winner at a set interval. Once the winner is selected, the lottery purchasers get their lottery tickets refunded, ensuring no-loss to all participants.
A key role of cryptocurrency is to allow decentralized and trustless value transfer between two parties. With the growth of DeFi, more creative payment methods are being innovated and experimented upon. The most popular projects working on decentralized payments are Lightning Network (Layer 2 on Bitcoin), Request Network and xDai.
Another interesting DeFi project that aims to change the way we approach payment by reconfiguring payments as streams instead of transactions is Sablier. The possibility of providing payments as streams open up a plethora of potential applications of money. Imagine “pay-as-you-use” but on a much more granular scale and higher accuracy.
The nascency of DeFi and the rate of innovation will undoubtedly introduce new ways of thinking on how payments work to address many of the current financial system’s shortcomings.
Insurance is a risk management strategy in which an individual receives financial protection or reimbursement against losses from an insurance company in the event of an unfortunate incident. It is common for individuals to purchase insurance on cars, home, health, and life. But is there decentralized insurance for DeFi?
All of the tokens locked within smart contracts are potentially vulnerable to smart contract exploits due to the large potential payout possible. While most projects have gotten their codebases audited, we never know if the smart contracts are truly safe, and there is always a possibility of a hack that may result in a loss. The risks highlight the need for purchasing insurance, especially if one deals with large amounts of funds on DeFi. An example of a decentralized alternative to insurance is the protocol Nexus Mutual.
Governance is essentially crypto’s idea of business management. In order for DeFi protocols to manage a project, governance tokens are often introduced to give users voting power and have a say in the protocol’s roadmap. This is used in Decentralized Autonomous Organization. Naturally, multiple toolkits and Dapps have also been developed to facilitate effective governance and complement existing systems.
The most popular governance coin right now is Aragon. Find out more about building your own DAO and using Aragon for governance plugins.
Bonus: check out Snapshot and their solution to governance voting without high transaction fees.
Last Updated on 08/04/2022 by Jeremy Timessen