This time we will talk about DeFi applications, an area that is in full swing, if you are not familiar with the term DeFi you can check our article where we talk about it. Anyway, we will make a brief summary of what DeFi applications are.
We previously defined DeFi as decentralized finance. They represent an alternative to the traditional financial system as we know them, they have many advantages and they present considerable growth at present.
DeFi applications take advantage of the tokenization process and the network of some cryptocurrencies that work with smart contracts, by their name in English. Although only 5% of the population owns cryptocurrencies, it is a growing technology.
Now yes, let’s review what they are for and what benefits they can offer.
Bitcoin and Ethereum are the original products of the DeFi philosophy, which aims to separate the finances of intermediaries, hence the term decentralized. The main idea is to carry out financial activities without the intervention of external agents such as governments, banks, regulators, etc. To explicitly leave it, we will define DeFi as follows:
There is a wide variety of DeFi applications, most of them run on the Ethereum network and we can classify them according to their functionality in the following categories:
In this article we are going to delve a little more into the functionality of the main services, as well as how DeFi applications are expanding to new services and areas.
Bitcoin and the first cryptocurrencies were born with the purpose of decentralizing the issuance and storage of our money, but they still have some limitations, such as access to the financial system, and this is precisely what DeFi applications come to solve.
Bitcoin currently has a scalability problem, which is why it is usually more used as a store of value than as a means of payment, however the first DeFi application that we are going to mention is the Lightning Network, this second layer on the Bitcoin network enables users the creation of payment channels and micro payments, which replaces the payment processor, and allows to process transactions economically and quickly, with no limit on low amounts.
In this way, commercial processors such as PayPal are eliminated, for example, and two people can make payments quickly, economically and without waiting for the confirmation of Bitcoin blocks through a decentralized payment channel executed over the Bitcoin network. . However, there are also other DeFi applications for payment networks such as Flexa and Fuse.
This is perhaps the most popular category of DeFi applications in the entire ecosystem, since the platforms connect users interested in depositing funds and earning interest, with users who require a loan and have cryptocurrencies that they can use as collateral, thus achieving that smart contracts connect lenders and borrowers, eliminating the use of traditional services such as banking.
MakerDao is the most popular platform in this line, it allows users to use their ETH tokens to generate a stablecoin called DAI, which has a value linked to the US dollar of approximately 1: 1. Users who leave their ETHs as collateral obtain DAI as a form of liquidity and the smart contract is responsible for managing interest and collateral. Due to this popular application, DAI has become one of the most popular stablecoins in the crypto space.
Thanks to this system, other stable currencies such as TrueUSD, EosDT, Gemini Dollar, Paxos Standard, and USD Coin, have stood out in DeFi applications.
Exchanges or decentralized exchanges are another example of the use of smart contracts to enforce business rules, execute asset exchanges and manage funds safely, since it allows the purchase and sale of cryptocurrencies or tokens, without storing the value directly.
These exchanges involve a smart contract where only the users who carry out the operation have access to the funds, since the exchange does not have the private keys of the wallets where the deposited values are located.
Another rapidly growing sector among DeFi applications is asset management or custody services, which are applications or wallets that allow users to put their money into smart contracts and manage asset portfolios. The most popular in this category are MetaMask, MyCripto, TrustWallet and some projects that have been gaining ground such as Argent and MyEtherWallet.
A derivative is basically a smart contract between two or more parties, whose value is determined by the performance of an underlying asset, which can be a stock, an index, raw material, cryptocurrency, the price of a pair of fiat currencies, etc. It is an alternative to CFDs (contracts for difference) that are usually traded as a financial instrument in many international markets.
To understand the usefulness of this DeFi application in a simpler way, let’s assume that we have on one side a user looking for a low-risk environment, where there is no significant variation in the price of a specific asset (underlying asset) On the other hand, we have another user who seeks to be exposed to this price variation (speculation) because he wants to take advantage of the price difference, the smart contract connects them to “transfer the risk.”
How is the risk transferred? Let’s apply a more concrete example, let’s assume that we have a company that is dedicated to making corn-based products (underlying asset), this company does not want to have the uncertainty of the price variation for the next quarter of corn, it wants to ensure that It won’t be too expensive in the future so you are willing to pay an additional premium to maintain price stability. And on the other hand we have other merchant users who want to speculate on the price of corn, who do not care about the real cost of corn, but the volatility to make an economic profit, so the smart contract connects the corn buyer with the speculator, where the company wants to preserve capital and the speculator wants to take the risk of the operation.
It is a concept a bit complicated to understand, if you do not do a practical example. In this category we have synthetix where you can trade unguarded tokens and cryptocurrencies that provide exposure to the underlying asset, for people familiar with traditional financial markets will find in this an alternative to CFDs and the futures market.
Prediction markets are similar to derivatives markets, in the end these prediction markets allow users to bet on the outcome of any event, the best known example of these DeFi applications is Augur, the fundamental difference with traditional betting applications It is the decentralized character that allows a more transparent management of funds, through the use of smart contracts.
PoolTogether stands out as a highly controversial DeFi application, where users have the possibility to buy a lottery ticket with stablecoins such as DAI or USDC, these tickets are accumulated in a weekly well and on Fridays a draw is held where it is a winner, until At this point there is no news, the true innovation of this DeFi application is that nobody loses.
Yes, you read correctly: nobody loses. This is due to the principle of operation of the smart contract, which takes the funds from the tickets and places them on a loan, on a decentralized loan platform during the week of the draw, where then the smart contract makes the payment of the cost of the ticket plus the interest of the loan to the winner and the amount of the tickets are returned to the user, who is not a winner.