Introduction to DeFi?

DeFi is an open and global financial system built for the internet age – an alternative to a system that’s opaque, tightly controlled, and held together by decades-old infrastructure and processes. It gives you control and visibility over your money. It gives you exposure to global markets and alternatives to your local currency or banking options. DeFi products open up financial services to anyone with an internet connection and they’re largely owned and maintained by their users. So far tens of billions of dollars worth of crypto has flowed through DeFi applications and it’s growing every day.

DeFi is a collective term for financial products and services that are accessible to anyone who can use Ethereum – anyone with an internet connection. With DeFi, the markets are always open and there are no centralized authorities who can block payments or deny you access to anything. Services that were previously slow and at risk of human error are automatic and safer now that they’re handled by code that anyone can inspect and scrutinize.

There’s a booming crypto economy out there, where you can lend, borrow, long/short, earn interest, and more. Crypto-savvy Argentinians have used DeFi to escape crippling inflation. Companies have started streaming their employees their wages in real time. Some folks have even taken out and paid off loans worth millions of dollars without the need for any personal identification.

DeFi vs traditional finance

One of the best ways to see the potential of DeFi is to understand the problems that exist today.

• Some people aren’t granted access to set up a bank account or use financial services.
• Lack of access to financial services can prevent people from being employable.
• Financial services can block you from getting paid.
• A hidden charge of financial services is your personal data.
• Governments and centralized institutions can close down markets at will.
• Trading hours often limited to business hours of specific time zone.
• Money transfers can take days due to internal human processes.
• There’s a premium to financial services because intermediary institutions need their cut.

A comparison

DeFi	Traditional finance
You hold your money.	Your money is held by companies.
You control where your money goes and how it’s spent.	You have to trust companies not to mismanage your money, like lend to risky borrowers.
Transfers of funds happen in minutes.	Payments can take days due to manual processes.
Transaction activity is pseudonymous.	Financial activity is tightly coupled with your identity.
DeFi is open to anyone.	You must apply to use financial services.
The markets are always open.	Markets close because employees need breaks.
It’s built on transparency – anyone can look at a product’s data and inspect how the system works.	Financial institutions are closed books: you can’t ask to see their loan history, a record of their managed assets, and so on.

It started with Bitcoin…

Bitcoin in many ways was the first DeFi application. Bitcoin lets you really own and control value and send it anywhere around the world. It does this by providing a way for a large number of people, who don’t trust each other, to agree on a ledger of accounts without the need for a trusted intermediary. Bitcoin is open to anyone and no one has the authority to change its rules. Bitcoin’s rules, like its scarcity and its openness, are written into the technology. It’s not like traditional finance where governments can print money which devalues your savings and companies can shut down markets.

Ethereum builds on this. Like Bitcoin, the rules can’t change on you and everyone has access. But it also makes this digital money programmable, using smart contracts, so you can go beyond storing and sending value

Programmable money

This sounds odd… “why would I want to program my money”? However, this is more just a default feature of tokens on Ethereum. Anyone can program logic into payments. So you can get the control and security of Bitcoin mixed with the services provided by financial institutions. This lets you do things with cryptocurrencies that you can’t do with Bitcoin like lending and borrowing, scheduling payments, investing in index funds and more.

What can you do with DeFi?

There’s a decentralized alternative to most financial services. But Ethereum also creates opportunities for creating financial products that are completely new. This is an ever-growing list.

• Send money around the globe
• Stream money around the globe
• Access stable currencies
• Borrow funds with collateral
• Borrow without collateral
• Start crypto savings
• Trade tokens
• Grow your portfolio
• Fund your ideas
• Buy insurance
• Manage your portfolio

Send money around the globe quickly

As a blockchain, Ethereum is designed for sending transactions in a secure and global way. Like Bitcoin, Ethereum makes sending money around the world as easy as sending an email. Just enter your recipient’s ENS name (like bob.eth) or their account address from your wallet and your payment will go directly to them in minutes (usually). To send or receive payments, you will need a wallet

Access stable currencies

Cryptocurrency volatility is a problem for lots of financial products and general spending. The DeFi community has solved this with stablecoins. Their value stays pegged to an another asset, usually a popular currency like dollars.

Coins like Dai or USDC have a value that stays within a few cents of a dollar. This makes them perfect for earning or retail. Many people in Latin America have used stablecoins as a way of protecting their savings in a time of great uncertainty with their government-issued currencies.

Borrowing

Borrowing money from decentralized providers comes in two main varieties.

• Peer-to-peer, meaning a borrower will borrow directly from a specific lender.
• Pool-based where lenders provide funds (liquidity) to a pool that borrowers can borrow from.

Borrowing with privacy

Today, lending and borrowing money all revolves around the individuals involved. Banks need to know whether you’re likely to repay a loan before lending.

Decentralized lending works without either party having to identify themselves. Instead the borrower must put up collateral that the lender will automatically receive if their loan is not repaid. Some lenders even accept NFTs as collateral. NFTs are a deed to a unique asset, like a painting. 

This allows you to borrow money without credit checks or handing over private information.

Access to global funds

When you use a decentralized lender you have access to funds deposited from all over the globe, not just the funds in the custody of your chosen bank or institution. This make loans more accessible and improves the interest rates.

Tax-efficiencies

Borrowing can give you access to the funds you need without needing to sell your ETH (a taxable event). Instead you can use ETH as collateral for a stablecoin loan. This gives you the cash-flow you need and lets you keep your ETH. Stablecoins are tokens that are much better for when you need cash as they don’t fluctuate in value like ETH. More on stablecoins

Flash loans

Flash loans are a more experimental form of decentralized lending that let you borrow without collateral or providing any personal information.

They’re not widely accessible to non-technical folks right now but they hint at what might be possible to everyone in the future.

It works on the basis that the loan is taken out and paid back within the same transaction. If it can’t be paid back, the transaction reverts as if nothing ever happened.

The funds that are often used are held in liquidity pools (big pools of funds used for borrowing). If they are not being used at a given moment, this creates an opportunity for someone to borrow these funds, conduct business with them, and repay them in-full quite literally at the same time they’re borrowed.

This means a lot of logic must be included in a very bespoke transaction. A simple example might be someone using a flash loan to borrow as much of an asset at one price so they can sell it on a different exchange where the price is higher.

So in a single transaction the following happens:

• You borrow X amount of $asset at $1.00 from exchange A
• You sell X $asset on exchange B for $1.10
• You pay back loan to exchange A
• You keep the profit minus the transaction fee

If exchange B’s supply dropped suddenly and the user wasn’t able to buy enough to cover the original loan, the transaction would simply fail.

To be able to do the above example in the traditional finance world, you’d need an enormous amount of money. These money-making strategies are only accessible to those with existing wealth. Flash loans are an example of a future where having money is not necessarily a prerequisite for making money.

Start saving with crypto

Lending

You can earn interest on your crypto by lending it and see your funds grow in real time. Right now interest rates are much higher than what you’re likely to get at your local bank (if you’re lucky enough to be able to access one). Here’s an example:

• You lend your 100 Dai, a stablecoin, to a product like Aave.
• You receive 100 Aave Dai (aDai) which is a token that represents your loaned Dai.
• Your aDai will increase based on the interest rates and you can see your balance growing in your wallet. Dependent on the APR, your wallet balance will read something like 100.1234 after a few days or even hours!
• You can withdraw an amount of regular Dai that’s equal to your aDai balance at any time

No-loss lotteries

No-loss lotteries like PoolTogether are a fun and innovative new way to save money.

• You buy 100 tickets using 100 Dai tokens.
• You receive 100 plDai representing your 100 tickets.
• If one of your tickets is picked as the winner, your plDai balance will increase by the amount of the prize pool.
• If you don’t win, your 100 plDai rolls over to next week’s draw.
• You can withdraw an amount of regular Dai that’s equal to your plDai balance at any time.

The prize pool is generated by all the interest generated by lending the ticket deposits like in the lending example above.

Exchange tokens

There are thousands of tokens on Ethereum. Decentralized exchanges (DEXs) let you trade different tokens whenever you want. You never give up control of your assets. This is like using a currency exchange when visiting a different country. But the DeFi version never closes. The markets are 24/7, 365 days a year and the technology guarantees there will always be someone to accept a trade.

For example, if you want to use the no-loss lottery PoolTogether (described above), you’ll need a token like Dai or USDC. These DEXs allow you to swap your ETH for those tokens and back again when you’re finished.

Advanced trading

There are more advanced options for traders who like a little more control. Limit orders, perpetuals, margin trading and more are all possible. With Decentralized trading you get access to global liquidity, the market never closes, and you’re always in control of your assets.

When you use a centralized exchange you have to deposit your assets before the trade and trust them to look after them. While your assets are deposited, they’re at risk as centralized exchanges are attractive targets for hackers.

Fund your ideas

Ethereum is an ideal platform for crowdfunding:

• Potential funders can come from anywhere – Ethereum and its tokens are open to anybody, anywhere in the world.
• It’s transparent so fundraisers can prove how much money has been raised. You can even trace how funds are being spent later down the line.
• Fundraisers can set up automatic refunds if, for example, there is a specific deadline and minimum amount that isn’t met

Quadratic funding

Ethereum is open source software and a lot of the work so far has been funded by the community. This has led to the growth of an interesting new fundraising model: quadratic funding. This has the potential to improve the way we fund all types of public goods in the future.

Quadratic funding makes sure that the projects that receive the most funding are those with the most unique demand. In other words, projects that stand to improve the lives of the most people. Here’s how it works:

1. There is a matching pool of funds donated.
2. A round of public funding starts.
3. People can signal their demand for a project by donating some money.
4. Once the round is over, the matching pool is distributed to projects. Those with the most unique demand get the highest amount from the matching pool.

This means Project A with its 100 donations of 1 dollar could end up with more funding than Project B with a single donation of 10,000 dollars (dependent on the size of the matching pool)

Insurance

Decentralized insurance aims to make insurance cheaper, faster to pay out, and more transparent. With more automation, coverage is more affordable and pay-outs are a lot quicker. The data used to decide on your claim is completely transparent.

Ethereum products, like any software, can suffer from bugs and exploits. So right now a lot of insurance products in the space focus on protecting their users against loss of funds. However there are projects starting to build out coverage for everything life can throw at us. A good example of this is Etherisc’s Crop cover which aims to protect smallholder farmers in Kenya against droughts and flooding. Decentralized insurance can provide cheaper cover for farmers who are often priced out of traditional insurance.