We are all familiar with Traditional Finance(TradFi) systems and the hassle and tassel that comes with them. Although they have been the backbone of the global economy for decades, there are situations where they fail to meet the needs of users effectively. For instance, many people in emerging economies don’t have access to banking services because they don’t have sufficient processing documentation, live too far from banks, or don’t understand the general banking industry and products. Additionally, the high costs associated with banking, trading, and other financial services make it difficult for many people to participate.
Decentralized Finance (DeFi) is a promising alternative that uses blockchain technology, cryptography, and smart contracts to offer a more accessible, secure, and transparent financial system. In this article, we will provide an overview of DeFi, popular elements/applications of DeFi, DeFi product management, and the future of DeFi.
A Brief Overview of the DeFi Ecosystem
The main value proposition for DeFi, and by extension, the blockchain industry, is to eliminate the intermediaries associated with TradFi and empower individuals. Unlike the traditional financial system, which relies on banks, brokers, and other intermediaries to facilitate transactions, DeFi allows users to transact directly with one another in a decentralized, transparent, secure, permissionless and automated way.
The limitations of the traditional financial system emphasize the need for DeFi systems. Traditional financial services are expensive, slow, and not accessible to everyone. Also, they are centralized and harbor many intermediaries which exercise control over financial transactions and sometimes create vulnerabilities in the system.
DeFi aims to address these limitations by providing a more accessible, transparent, and decentralized financial system. With DeFi, anyone with an internet connection can access financial services without relying on intermediaries.
Popular Elements/Applications of DeFi
To properly explain the fundamentals of DeFi systems, certain key elements should be discussed. These elements form the backbone and structure of the current DeFi ecosystem. They include Stablecoins, Lending and Borrowing Systems, and Decentralized Exchanges.
Stablecoins are cryptocurrencies designed to maintain a stable value relative to a specific asset, such as the US dollar or gold. Stablecoins are essential in DeFi because they provide a bridge between the crypto markets and the traditional financial markets. There are two types of stablecoins: fiat-backed stablecoins and algorithmic stablecoins.
Fiat-backed stablecoins are cryptocurrencies backed by traditional currencies like the US dollar, Euro, or Yen. Fiat-backed stablecoins are the most popular type of stablecoins and are designed to provide stability and security for DeFi users. For every dollar of fiat-backed stablecoin on the blockchain, an equivalent amount of cash should be reserved in the real world. Examples of fiat-backed stablecoins include Tether(USDT), USD Coin(USDC), and Binance USD(BUSD).
Algorithmic stablecoins, on the other hand, are not backed by any underlying reserve asset. Instead, a complex algorithm maintains their value by ensuring price stability. For instance, if the price of an algorithmic stablecoin goes above its target value, the algorithm can mint new tokens to reduce demand and lower the price. Conversely, if the price goes below the target value, the algorithm can burn tokens from the system and reduce the supply, increasing demand and raising the price. The specific mechanisms used by algorithmic stablecoins vary depending on the project. Some use a combination of price oracles(real-world financial databases e.g. Chainlink and Automated Market Makers (AMMs) to determine the token price and regulate supply. In contrast, others use complex economic models to manage a token’s value. Examples of algorithmic stablecoins include Ampleforth(AMPL), DAI, and FRAX.
Lending & Borrowing Protocols
DeFi lending and borrowing protocols allow users to lend and borrow cryptocurrencies without intermediaries and at very low costs. These protocols leverage smart contracts to allow users to earn interest on their idle crypto assets and borrow crypto assets from other users without going through any middle-man like with traditional finance. This borrowing and lending are facilitated entirely by the smart contract with no human involvement. Examples of popular DeFi lending and borrowing protocols include Aave, Compound, and MakerDAO.
Decentralized Exchanges (DEXs)
Decentralized Exchanges (DEXs) allow users to trade cryptocurrencies without intermediaries. DEXs use Liquidity Pools and Automated Market Making (AMM) systems to ensure that trades are executed without issues.
Liquidity pools are pools of cryptocurrencies that are locked in smart contracts and used to facilitate trades. People who deposit their cryptocurrencies in Liquidity Pools are called “Liquidity Providers(LPs).” Liquidity providers deposit their unused cryptocurrencies in liquidity pools to help the community while earning interest.
Automated Market Making is a mathematical procedure that determines the price of a cryptocurrency based on its supply and demand dynamics in the system. Liquidity Pools are organized in trading pairs and liquidity providers choose which pairs to contribute to when making deposits. These pools are used to execute trades between two assets at a price determined by the algorithm. This is done by tracking the ratio of the assets in the pool. When a user wants to trade one cryptocurrency for another on the DEX, the transaction is executed against the liquidity pool rather than against a traditional order book, as is the case on centralized exchanges like Binance. The AMM algorithm instead calculates the appropriate exchange rate based on the current pool dynamics, and the transaction is executed automatically. StarkDeFi provides decentralized exchange services that leverage liquidity pools and automated market making. It has been cleverly designed for the average user for optimum user experience. Some other popular examples of DEXs include Uniswap, SushiSwap, and Balancer.
DeFi product management — DAOs
Decentralized Autonomous Organizations (DAOs) are another critical element of DeFi. A DAO is a decentralized organization that operates on a blockchain and is governed by its members. DAOs use smart contracts and governance tokens to automate decision-making and eliminate the need for long bureaucracies. StarkDeFi’s governance token is $SDC. Members of a DAO can vote on proposals, allocate funds, and participate in the organization’s governance. DAOs are essential in DeFi because they allow users to govern DeFi protocols while ensuring that they are decentralized and transparent. You can make key decisions in StarkDeFi’s DAO by joining the Telegram channel and Discord server.
Decentralized Finance (DeFi) is an exciting alternative to the traditional financial system. DeFi offers a more accessible, transparent, and decentralized financial system powered by blockchain technology. It aims to provide users with the ability to transact directly with each other without intermediaries and eliminates the need for traditional financial institutions and fees.
The future of DeFi looks promising as more people become aware of its benefits and start to use it. We at StarkDeFi work tirelessly to achieve this goal. DeFi also has the potential to transform the global financial system and provide financial inclusion for billions of people currently underserved by the traditional financial system.