Understanding What is DeFi and How It Works

Understanding What is DeFi and How It Works
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    Last updated on August 18th, 2020 at 08:35 pm

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    What is DeFi:

    It is called DeFi, a short way for writing ‘Decentralized Finance.’ DeFi creators recreate the traditional financial instruments in a decentralized style. 

    DeFi is also known as Open Finance because it is transparent, easily accessible by anyone with smartphone and knowledge of how it works.

    These new decentralized architecture is not controlled neither by the company nor the government, hence the term decentralized—free from control by central authority.

    One of the most successful DeFi tokens is Compound, a crypto version of Lending protocol where accrued interest is distributed to an insurance reserve.

    Similarities Between DeFi and Traditional Finance System:

    Financial services common to traditional finance is currently evolving onto the new technology called blockchain. Services like Lending, Savings, Borrowing, Interest loan, Insurance etc has now entered into the decentralized way of finance.

    Crypto Capital Assets Market offers a decentralized architecture for full control of funds unlike the traditional Capital Markets.

    DeFi is powered by tokens known as DeFi tokens mostly run on Ethereum blockchain created through smart contracts that execute on preprogrammed terms.

    DeFi depends on Dapps to function. A Dapp is a decentralized application or an application designed to work only within decentralized networks.

    These decentralized networks can be blockchain, Tor networks, or Distributed Ledgers Technologies (DLT). Most commonly used network is the Ethereum blockchain network.

    DeFi can provide the unbanked in Nigeria with access to financial services and bring about a faster way of achieving financial inclusion in Nigeria.

    Some DeFi Tokens, Protocols and How it Functions:

    Compound a popular DeFi blockchain network allow users to lend their crypto out to other users. Loan providers earn or receive interest in the form of cryptocurrency. 

    Compound utilizes smart contracts to match lenders and borrowers. These smart contracts on its network automatically make interest adjustments in line with the market’s current value.

    Read Also: Blockchain Will Help Nigeria to Achieve Financial Inclusion Through Mobile Money Services.

    Bancor Network is also a popular DeFi that distributes a portion of the trading fees from the platform to the token holders who are providing liquidity on the platform.

    These distributions come inform of ‘Interest on Saving’ which are send out to BNT liquidity providers utilizing smart contracts.

    Other Key DeFi Protocols According to Bankless Include:

    • 0x – Liquidity protocol – Market fees are distributed to ZRX tokenholders/ liquidity providers. 
    • Aave – Lending protocol – A portion of the interest accrued is distributed to LEND tokenholders through burns.
    • Augur – Derivatives protocol – Fees from prediction markets are distributed to REP tokenholders for participation. 
    • Kyber – Liquidity protocol – A portion of trading fees are distributed to KNC tokenholders via token burns or dividends for governance participation (Katalyst Upgrade). 
    • Maker – Lending protocol – Interest accrued on the outstanding Dai is distributed to MKR holders in the form of token burns. 
    • Synthetix – Derivatives protocol – Trading fees are distributed to SNX  holders for minting Synths. 
    • Ren – DEX – cross-chain swap fees are distributed to Ren Darknodes. 
    • Loopring – liquidity protocol – A portion of trading fees are distributed to LRC tokenholders. 
    • Gnosis – DEX – no value accrual yet but possibly trading fees in future.
    • Balancer – liquidity protocol – trading fees are distributed to Balancer liquidity providers.

    DeFi adoption is fast growing than expected with over $9 billion market capitalization according to CoinMarketcap.

    Trading DeFi Tokens

    World’s leading cryptocurrency exchanges like OKEx offers cryptocurrency trading including trading for DeFi tokens with enough liquidity.

    Trading DeFi tokens will be much easier. It will increase the volume of traded assets around the world with top crypto exchanges like OKEx taking the lead.

    Unlike some unfriendly features like account recovery on losing access to the account which is impossible with DeFi.sing OKEx will help mitigate these issues for new entrants.

    The system of traditional finance is evolving into a democratic finance whereby everyone has full access and control of their funds thus achieving financial inclusion around the globe.

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    1 Comment

    1. Eddie

      Decentralized Finance is currently the trending technology in the crypto industry for obvious reasons. It is highly prospective and promising with several projects seeing massive gains and patronage. Injective protocol has recognised this and is coming up with one of the most sophisticated platforms in the industry to further promote DEFIs and bring about more accessibility and recognition for decentralized Finance. Check them out.

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