DeFi is the hottest topic discussed by the community of cryptocurrency enthusiasts in 2020. Let’s try to figure out why the DeFi ecosystem became so popular this year. DeFi aka Decentralized Finance is fundamentally different from traditional banking services. Cryptocurrencies can eliminate such intermediaries as financial institutions, and transferring digital assets between wallets is cheaper and faster than using a bank transfer.
Also, decentralized finance is an option for people who do not have access to banking services. All they need to participate in the DeFi ecosystem is to have a smartphone with Internet access. The source code of DeFi projects is transparent and open for audit. This eliminates the risk of possible bankruptcies of the banks. However, this does not turn the DeFi ecosystem into a money-printing machine, and the risks in this area also exist. We will consider the risks in more detail below.
There are different DeFi use cases:
- Lending and borrowing
- Portfolio management
In general, in 2020 we can already talk about the existence of a decentralized ecosystem, fully independent of authorities and regulators. This is both the strength and weakness of decentralized finance.
For example, a listing of token-doubles often happens on Uniswap and other decentralized exchanges, when the name of such a token is identical to the name of the already well-known cryptocurrency. There are also some registered cases of money laundering going through Uniswap as a result of hacking and other illegal activities.
How DeFi works: a look from the inside
Almost all modern decentralized ecosystems work on the basis of Ethereum and “smart contracts”.
Decentralized exchanges require the locked cryptocurrency. If in early 2019 the total amount of such a lock was $275 million, by August 30, 2020 the total value of crypto locked in DeFi was $8 billion. In this case, the growth of total locked value in August 2020 was 85%. By September 28, the total amount of cryptocurrency lock reached $11 billion.
Ethereum Virtual Machine allows executing “smart contracts”. For the execution of a contract, there is a fee called gas. The amount of this fee is floating, it depends on the load of the Ethereum network. The decentralized application interface is the same as for a regular web or mobile application. However inside they rely on the Ethereum blockchain. The Decentralized ledger can also be applied to confirm that the user data is unchanged.
Recently a phenomenon called farming (mining of liquidity) has gained popularity as a kind of earnings in cryptocurrency. It relies entirely on “smart contracts”. The liquidity pool is filled in with Ethereum. It serves as a reserve for decentralized exchange. Farming is different from stacking in projects that use PoS (Proof of stake) and DpoS (delegated Proof of stake) algorithms. Availability of funds in the liquidity pool does not impose duties to maintain the operability of a blockchain and does not give the right to manage further development of the project. The liquidity pool is connected with the blockchain with the help of smart contracts. These contracts both block the funds and reward the owner of the liquidity pool. This reward is paid in tokens, which can both rise in price and fall obviously. Some users have managed to build profitable chains in which the tokens they receive serve as collateral for other tokens.
The most well-known DeFi projects
The Uniswap project received favorable attention and early funding from the founder of Ethereum, Vitaly Buterin. Now Uniswap confidently ranks first among the Ethereum projects in commission costs. Daily trading volume is over $500 million there, which is more than the Coinbase Pro or Kraken stock exchanges have. Even registration is not required for transactions there. There is no account, and to start working with it people just need to turn on the MetaMask wallet program. The project uses its own UNI token, which is already represented at many major stock exchanges and also on SimpleSwap.
Just in a day the UNI token rose from 203rd to 26th place in its popularity among all cryptocurrencies. Ethereum miners have earned for these days more than $1 million, significantly increasing commissions in the network. More than 100,000 users received a gift from Uniswap: about $1,000 UNI tokens. One of the Uniswap users received $400,000 in UNI tokens, and five users received $250,000 worth of tokens. The size of the award for the project participants depended on the amount in the liquidity pool that they managed to provide on the platform.
SushiSwap became a clone and the closest competitor to Uniswap. Almost immediately, a couple of weeks after the launch, the SUSHI project began to yield a profit of 1500% per annum. And all participants of the project started to get SUSHI as passive income. Three weeks after the launch of Sushiswap the number of blocked funds in the liquidity pool of the project reached $1 billion. And this is despite the withdrawal of $14 million, which was made on September, 5 by an anonymous founder of the project who calls himself a “cook chef”. His escapade attracted the attention of the FBI and the U.S. Internal Revenue Service. As a result, some of the funds were returned to the stock exchange.
Yearn.finance is an automated program for earning money in a liquidity pool. Users only need to specify the name of their tokens for the system to select several potentially profitable options of farming (liquidity mining). Yearn.finance also chooses the ways to get rare tokens that require a multi-step exchange of cryptocurrencies.
Yearn.finance provides background information on what cryptocurrencies allow you to get income from stacking or getting loans. The internal YFI token allows people to vote for further ways of project development. In the summer of 2020, its cost did not exceed $3. Then, continuously expensive, YFI reached a peak value at levels above $40,000 (September 2020). Since then, the YFI price has decreased. However, the YFI token still remains one of the most popular tokens on the decentralized exchanges.
Further prospects for the development of DeFi
An important advantage of DeFi applications is independence from third-party influence. Furthermore, it is borderless, permissionless to participate, and runs without a central authority. There is full control of the user’s money.
The disadvantage of DeFi is that smart contracts can have errors, as well as the fact that programs may be hacked. One of such hacks has previously led to the theft of the equivalent of about $50 million from the decentralized fund of the DAO and, as a consequence, to the splitting of the Ethereum blockchain. Also, the decentralized applications have problems with scalability. So far, DeFi relies almost entirely on the Ethereum Virtual Machine. If popularity of DeFi grows, it will be further entrenched in the technical limitations of the Ethereum network.
Thank you for reading the article about Decentralized Finance. Let’s keep an eye on the development of the DeFi trend together. If you are interested in purchasing some DeFi tokens, you are always welcome to get them on SimpleSwap!