Fervent proponents of cryptocurrencies and the blockchains they run on have promised a lot. To them, these technologies represent salvation from corporate power over the internet, government intrusions on liberty, poverty, and virtually everything else that ails society. But so far, the reality has mostly involved financial speculation with popular cryptocurrencies like Bitcoin and Dogecoin, which soar and plunge with alarming regularity. So DeFi network was introduced.
So what are cryptocurrencies and Blockchain good for?
As an expert on emerging technologies, I believe that decentralized finance, known as the DeFi network, is the first solid answer to that question. DeFi refers to financial services that operate entirely on blockchain networks, rather than through intermediaries like banks.
But DeFi network comes with a host of risks as well that developers and regulators will need to address before it can go mainstream.
Anyone can use DeFi products by going to an application’s website and connecting with a DeFi-enabled crypto wallet, such as MetaMask on Ethereum or Fantom on Solana. Most DeFi dApps do not require users to give up any personal information or register.
However, because the applications are built atop a blockchain, you must use that Blockchain’s coins to pay for transactions. ETH is required to pay for transactions on the Ethereum network. SOL is necessary on the Solana blockchain, and so forth.
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What is DeFi Network?
Traditionally, if you want to borrow US$10,000, you first need some assets or money already in the bank as collateral.
A bank employee reviews your finances, and the lender sets an interest rate for the repayment of your loan. The bank gives you the money out of its pool of deposits, collects your interest payments, and can seize your collateral if you fail to repay.
Everything depends on the bank: It sits in the middle of the process and controls your money.
The same is true of stock trading, asset management, insurance, and every form of financial service today. Even when a financial technology app such as Chime, Affirm, or Robinhood automates the process, banks still occupy the same intermediary role. That raises the cost of credit and limits borrower flexibility.
DeFi turns this arrangement on its head by re-conceiving of financial services as decentralized software applications that operate without ever taking custody of user funds.
Want a loan? You can get one instantly by simply putting cryptocurrency up as collateral. This creates a “smart contract” that finds your money from other people. People who made a pool of funds available on the blockchain. No bank loan officer is necessary.
Everything runs on so-called stablecoins, which are currency-like tokens typically pegged to the U.S. dollar to avoid the volatility of bitcoin and other cryptocurrencies. And transactions settle automatically on a blockchain – essentially a digital ledger of transactions that is distributed across a network of computers – rather than through a bank or other middleman taking a cut.
Transactions made this way can be more efficient, flexible, secure, and automated than in traditional finance.
Moreover, the DeFi network eliminates the distinction between ordinary customers and wealthy individuals or institutions, who have access to many more financial products. Anyone can join a DeFi loan pool and lend money to others. The risk is greater than with a bond fund or certificate of deposit, but so are the potential returns.
And that’s just the beginning. Because DeFi services run on open-source software code, they can be combined and modified in almost endless ways. For example, they can automatically switch your funds among different collateral pools based on which currently offers the best returns for your investment profile. As a result, the rapid innovation seen in e-commerce. And social media could become the norm in traditionally staid financial services.
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These benefits help explain why DeFi growth has been meteoric. At the recent market peak in May 2021, over $80 billion worth of cryptocurrencies were locked in DeFi network contracts, up from less than $1 billion a year earlier. The total value of the market was $69 billion as of Aug. 3, 2021.
That’s just a drop in the bucket of the $20 trillion global financial sectors, which suggests there is plenty of room for more growth.
At the moment, users have mostly experienced cryptocurrency traders, not yet the novice investors who have flocked to platforms like Robinhood. Even among cryptocurrency holders, just 1% have tried DeFi.
DeFi Network risks
While I believe the potential of DeFi is exciting, there are also serious causes for concern.
Blockchains can’t eliminate the risks inherent in investing, which are the necessary corollary of the potential for returns. In this case, the DeFi network can magnify the already high volatility of cryptocurrencies. Many DeFi network services facilitate leverage, in which investors essentially borrow money to magnify their gains but face a greater risk of losses.
Moreover, there isn’t any banker or regulator who can send back funds transferred in error. Nor is there necessarily someone to repay investors when hackers find a vulnerability in the smart contracts or other aspects of a DeFi service. Almost $300 million has been stolen in the past two years. The primary protection against unexpected losses is the warning “investor beware,” which has never proved sufficient in finance.
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Some DeFi services appear to violate regulatory obligations in the United States and other jurisdictions, such as not barring transactions by terrorists, or allowing any member of the general public to invest in restricted assets like derivatives. It’s not even clear how some of those requirements even could be enforced in DeFi without traditional intermediaries.
Even highly mature, highly regulated traditional financial markets experience shocks and crashes because of hidden risks, as the world saw in 2008 when the global economy nearly melted down because of one obscure corner of Wall Street. DeFi makes it easier than ever to create hidden interconnections that have the potential to blow up spectacularly.
Regulators in the U.S. and elsewhere are increasingly talking about ways to rein in these risks. For example, they are starting to push DeFi services to comply with anti-money laundering requirements and considering regulations governing stablecoins.
But so far they have only begun to scratch the surface of what may be required.
From travel agents to car salespeople, the internet has repeatedly undermined the bottleneck power of intermediaries. DeFi network is another example of how software based on open standards can potentially change the game dramatically. However, developers and regulators will both need to up their performance to realize the potential of this new financial ecosystem.
What Are Top 10 Uses of DeFi Network?
1) Decentralized exchanges. Decentralized exchanges generally have lower fees and now the bigger ones have the liquidity to rival many centralized exchanges. Many use liquidity pools and automatic market makers (AMMs) or use more directly P2P bid/ask mechanisms to match buyers and sellers. What they don’t have is centralized management that will do things like decide to compensate hack victims or respond to problems quickly. Nor do they hold your crypto’s private keys.
2) Derivatives. Smart contracts let parties enter derivatives like futures contracts, which are capable of going beyond bitcoin and other crypto assets. Anything from pork bellies to securities to market indexes can tokenize. Leverage of up to 100x on some exchanges can lead to frightening losses.
3) Lending/Borrowing. We went into this in Part 4, but a big, big use of DeFi is the decentralized lending and borrowing platforms that let crypto owners earn passive interest by lending (generally stablecoins) to people who put up crypto collateral, generally at 150% or more to account for volatility. Margin calls can wipe borrowers out by forcing the sale of assets as their prices crash.
4) Stablecoins. Most stablecoins keep their one-to-one dollar (or euro, yen, whatever) peg by holding a one-to-one basket of cash and highly liquid assets like short-term Treasury notes (tether, the largest stablecoin by far, not so much). But others, like Maker’s Dai, use various algorithmic tools to maintain the peg, such as minting coins to increase supply and (theoretically) lower prices or buying a burning to raise prices.
5) Marketplaces. Much like DEXs, why pay a centralized company to play middleman, when smart contracts can easily handle listing, buying, and selling things. Most notably NFTs, or non-fungible tokens, which contain digital media of some sort and prove its provenance. Say, $69 million collages or CryptoPunks.
6) Prediction Markets. In a way this is gambling, but there’s more to it. Participants bet on the outcome of anything from an election to whether the Federal Reserve will raise interest rates, with the odds used to predict the outcome. People tell the truth and indicate the strength of their beliefs because they are putting their money where their mouth is. So the theory goes.
7) Gaming. Axie Infinity is an NFT game that uses a DEX and allows participants to play-to-earn by farming goods that players will buy for real cryptocurrency. Sales and resales of its NFTs have reached $3.7 billion.
8) Metaverses. Thanks to Mark Zuckerberg, everyone interests metaverses. The 3D, VR “worlds” allow people to create and personalize avatars that can interact with others or with things. Buy property, build a game people can play, advertise a product on a digital billboard, and set up shop in a marketplace. Nike bought a company that makes fashion items for metaverse avatars, and plenty of corporations are getting interested, from Coca-Cola to Gucci. You can even sell real-world items from a metaverse store.
9) Payments. Peer-to-peer payments DApps like Flexa and Tornado Cash, have planted flags in payments. Jack Dorsey’s Square, however, is coming for them. P2P payments are the foundation not just of the DeFi network, but of blockchain itself. Line one of the Bitcoin Whitepaper: “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
10) Insurance. While the traditional insurance industry can do a great deal with smart contracts, DeFi insurance projects like Nexus Mutual creates shared risk pools that offer insurance for things like losses from a smart contract bug. Which is more or less exactly the way Lloyds of London works.
What Are the Top DeFi Blockchains?
Algorand (ALGO) offers 1,000 TPS, and transactions which completed in five seconds. Designed by Silvio Micali, an MIT computer science professor, and Turing Award winner, it manages this with a two-tiered structure. There’s a base level — known as Layer 1 — on which simple transactions that made and sent to be validated. All the more complex smart contract functions, such as running a DeFi network lending/borrowing platform. For example, run on Layer 2, shifting just the final transaction data to Level 1.
Most blockchains like Ethereum, bitcoin, and others are called Level 1 blockchains because everything is done on a single layer. There are some pure Layer 2 projects, such as Lightning Network. They were designed to lie on top of bitcoin and another single-layer blockchain to make them more scalable.
Avalanche (AVAX) can handle 4,500 TPS and has attracted some important Defi network projects like the bZx lending platform, SushiSwap decentralized exchange (DEX), and TrueUSD stablecoin. There are three “subnet” blockchains with different roles. Avalanche has an exchange chain (X) on which assets that exchanged. It is a smart contract (C) platform on which smart contracts run. And a platform (P) chain on which DeFi network projects can build their own “subnet” blockchain.
Binance Smart Chain — or BSC — is probably the fastest growing of the would-be Ethereum Killers, with its technology helped along by the name and reputation of the world’s largest crypto exchange. It works in conjunction with the centralized exchange’s other blockchain, Binance Chain (BC). Smart contracts run on BSC, which is parallel to BC, which runs transactions. Both use the Binance Coin (BNB), trading them across a Binance Bridge.
Cardano (ADA) – Ethereum Co-Founder Charles Hoskinsoncreated in 2017, making it one of the older competitors. A PoS chain with 266 TPS capacity, Cardano has a big advantage (or disadvantage, depending on your point of view) in that all code updates that rigorously peer-reviewed. It is working on a Layer 2 update to up its TPS to match later competitors.
Polygon is a scaling solution, a Layer 2 blockchain on top of Ethereum, intended to improve Ethereum’s scalability rather than replace it. Formerly known as Matic Network, Polygon offers developers a way to build scalable sidechains bound to Ethereum, using several methods. Its main Matic POS Chain adds PoS security to child chains built on it. Plasma Chains bundle transactions into a single block, with batches of blocks sent to Ethereum in a single submission via bridges. Zk-Rollups executes transactions and then sends only the proof of validity to Ethereum. Optimistic Rollups does the same, except it sends proof of fraudulent transactions.
Polkadot (DOT) is a “blockchain of blockchains” that will host 100 “parachains” that separate transactions from the actual smart contract action, sending only transactions to the main validation chain. What sets Polkadot apart is that the parachains will all interconnect, able to transfer data and tokens freely among themselves. It will also offer bridges to other blockchains, including Ethereum.
Solana (SOL) is the speed demon, with 50,000 TPS capacity. It achieves this by several methods. One is that it adds a consensus mechanism, PoH to PoS that speeds up the process. Precess by which validated transactions that accepted by all the nodes. Other components do things like assign the order and execution of transactions. And define how and when transactions that exchanged and verify each component of the transaction.
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The Future of DeFi
As of November 2020, companies locked less than $20 billion worth of value in various DeFi network products. Most of them were on Ethereum. By the following year, it was worth more than $260 billion, with $19 billion coming from Binance Smart Chain alone.
If the trend continues and the DeFi maximalists are right, this is just the beginning of a massive DeFi wave. True believers argue that the advantages of an open and DeFi system are simply too compelling to not capture trillions of dollars of value.
In November 2021, risk management firm Elliptic estimated about DeFi. DeFi network users lost $10.5 billion to hacks and scams over the preceding two years.
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The Bitcoin network was introduced to the world in 2009 by an unknown individual or group called Satoshi Nakamoto. In 2021, there are more than 10,000 different projects in the field of cryptocurrencies. Each of which, having its role in building the future of money.
The market value of cryptocurrencies reached $ 1 trillion for the first time in January 2021 and passed $ 2.5 trillion in less than three months later, which shows that this market is one of the growing markets in the favor of its investors.
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