What is DeFi? A Comprehensive Guide to Decentralized Finance (INSANE POTENTIAL)

What is DeFi? A Comprehensive Guide to Decentralized Finance (INSANE POTENTIAL)

Decentralized Finance (DeFi) is much ahead with a completely different intention to decentralizing financial services when compared to other innovation-driven projects. In the current financial system where thinking of running international transactions and other services without the intervention of any intermediary is impossible, DeFi has made it possible to a large extent leaving the control on users own. It has spread the wings very quickly to other services and products, which depicted to you from top to bottom.

Decentralized finance (DeFi)

Decentralized finance is written as DeFi in its short form. DeFi refers to the digital assets and financial smart contracts, protocols, and decentralized applications built on Ethereum. With the intention to creating multiple types of financial services and products, DeFi promotes the use of decentralized networks and open source software.

Functions that DeFi basically perform is that it creates monetary banking services, provides peer-to-peer platforms, and enables advanced financial instruments like DEX, tokenization platforms etc. DeFi services cover these three fields. The services by decentralized finance are secure and have come with several benefits that traditional financial services are failure to provide.

As many dApps are built on top of the Ethereum blockchain, it reduces operational costs and entry barriers deducting intermediaries improving security. This is how DeFi movement is shifting traditional financial products to the open source and decentralized world.

Traditional finance and Decentralized finance

Our traditional financial system hasn’t evolved in a day which started with barter trading system. With time, currencies were invented for exchanging things. This economy is centralized is centralized by governments and banks. While you can trust your bank for safely storing your money, you can’t on your government to not print more money overnight. But, the matter of regret of this current financial is that the power that comes along with this trust isn’t always rewarded.

While the government is managing the economy and corporations handling our investments, investors get a fraction of the returns.

Cutting down the need to trust anyone, DeFi is trying to create a financial system which is open to everyone. Internet, cryptography, and blockchain are helping to build such a system. ‘’Don’t trust, verify’’ is a saying in the blockchain space.

Financial prosperity with DeFi

Ethereum is a blockchain network that maintains a shared ledger of digital value and almost all DeFi applications are built on the Ethereum blockchain. Applications can be programmed by developers on Ethereum which can create, store, and manage digital assets on the blockchain.  These are known as smart contracts. With only internet connection, anyone can access and interact with smart contracts, which are in most of the cases open-source interoperable with existing smart contracts.

Popular DeFi applications

There are so many DeFi products and services indeed. Which one to start with? Then let’s start with DeFi’s borrowing and lending platforms, a popular and growing sector. Its procedures are quite likely to a bank but the alienation is in the decentralization system. Decentralized lending platforms provide loans to businesses, or the public with no intermediaries are present. DeFi lending protocols enable everyone to earn interest on supplied stable coins and cryptocurrencies.

Another type of popular DeFi application is decentralized exchange or DEX. A decentralized exchange, which is briefly known as DEX, is a peer-to-peer online service that allows direct cryptocurrency transactions between two interested parties. Stablecoins are also significant to the DeFi ecosystem.

Is DeFi likely to smart money Lagos?

Smart contracts are quite likely to smart money legos which you start out with a bunch of small bricks. You have more money Lego in your collection with the launch of each project, product, or service on Ethereum. You can think of cDAI as an example of money Legos in operation. You will receive cDAI at your supply of DAI to Compound, an ethereum project focused on allowing borrowers to take out loans and lenders to provide loans by locking their assets into the protocol. cDAI is the blend of your DAI in Compound and any interest you have earned from lending. All inherent features of a token are existed in cDAI as being a token.

Varying degrees of decentralization

As decentralization is of several types, not all services of DeFi need to be completely decentralized. DAI is more decentralized where other stablecoins are not even close to it. Many tokens represent fiat currency deposit. But in that case there is a limitation like as for example there is 1 USD being held in a bank somewhere for every USDC token. Sending, receiving, and trading can be done with these tokens on this blockchain, but a complete elimination of the necessity to physically manage the real world asset can’t be possible.

What in the world is Decentralized Finance?

The power of regulating and handling the flow and supply of our regular currencies is arrayed on governments and banks as our traditional finance market is centralized. All your risk is at the center as the full control of your fund is centralized.

One of the cardinal problems of centralized economy is that government can decide to print more money to tackle a financial crisis which most of the cases leads to high inflation ends up destroying economic balance.

People deposit money in banks with an eye to earning interest and banks invest this deposited money to different organizations and give money to borrowers against a high interest. And banks are paying a small fraction of return which is very less compared to your actual value. That’s why some are interested in investment.

Cryptocurrencies with decentralization

With peer-to-peer trading system, Bitcoins and early crypto coins have decentralized the issuing of money and its storage. But they haven’t yet been able to decentralize the financial system due to some hindrances:

-Cryptocurrencies even being decentralized, centralized access points are needed to make access to it.

-Most of the crypto projects are managed through centralized companies.

DeFi offerings

The cardinal purpose of DeFi is it is leaving you freedom and control on your own assets. While in the traditional financial system, you need to rely on intermediaries to manage your funds. Developers of financial apps turned their focus on adopting open-source protocols for trading through decentralized exchanges. This adoption is expected to leading to faster innovation and a secure network. The return through investing assets in blockchain is higher than from the traditional financial system.

Products of DeFi

Here we are discussing some of DeFi’s products.

Open Lending Protocols

This Open Lending Protocols work like a bank indeed and this protocol is strictly based on a public blockchain like Ethereum. Users deposit their money on this protocol and someone else borrows the digital assets and they earn interests. Here the smart contracts connect lenders and borrowers and distribute the interest. Here the interest is higher for lenders as intermediaries remain absent here.

MakerDAO has appeared as a dominant decentralized lending protocol. The platform leverages Ethereum smart contracts to automate the functions of a lending platform, and its associated stable coin in a decentralized manner. Dharma and BlockFi are also same kind of protocols indeed.


Stablecoins are blockchain-issued tokens designed to hold on to specific value and a stablecoin can be pegged to a cryptocurrency, fiat money, or to exchange-traded commodities. There are three categories of stablecoins:

1: Fiat-Collateralized.

2: Crypto- Collateralized.

3: Non- Collateralized.

#Fiat-Collateralized: These stablecoins keep a fiat currency reserve like the U.S. dollar or Euro. Generally, a fiat currency reserve is kept in a bank to uphold the current circulating supply of the token, thus this is centralized. Though it becomes centralized in a certain stage, there arises counterparty risk. These stablecoins are supposed to be redeemable at a 1:1 ratio with the pegged currency. Firms working behind these stablecoins are benefited by the interest earned on the deposited funds.

#Crypto- Collateralized: Stablecoins which are crypto-collateralized are backed by other cryptocurrencies. They maintain 1:1 ratio through over-collateralization. Though they rely on trustless issuance, this type of coin is transparent and Maker’s Dai, which is only composed of borrowers, is such a stablecoin. The collateral is held in a smart contract. The stablecoin system might close the smart contract and sell the collateral once excess collateral drops below a certain predetermined level. Volatility carries a great risk to this model.

#Non- Collateralized: These types of stablecoins are not backed by anything. The system being depended on an algorithm supplies more tokens with increased demand while the price of each token is lowered and vice versa to maintain stability. Take the example of ‘’Basis’’ stablecoin.

Exchanges and Open Marketplaces

As decentralized exchanges maintain the system of peer-to-peer transactions of digital assets between parties, it removes the necessity of any intermediary, sign-ups, no identity verification and withdrawl fees. There are a number of decentralized exchanges (DEXs) and P2P marketplaces available in market. Some methods adopted by DEXs are likely to centralized exchanges like atomic swap for swapping crypto tokens.

Several marketplaces focus on non-fungible tokens (NFTs) exchange like OpenSea and Rarebits are two such platforms.

Issuance and Invest Management Platforms

Platforms of this sector is finding and going directly towards the security token market. Two such notable security token issuance platforms are Polymath and Harbor. Issuers are allowed to launch tokenized securities on a blockchain of these platforms. To make sure additional assistance to issuers, these platforms maintain relationship with several other service providers. ST-20 and R-Token are standardized token contracts for securities of those platforms.

On the other hand, several smart contract-based asset management platforms provide a front-end digital asset management interface which is built on IPFS.

Is DeFi completely decentralized?

As not every single component is decentralized, there are several degrees of decentralization in DeFi services.

Degree 0 Defi aka CeFi: The broad meaning of CeFi is Centralized Finance and its products are custodial actually like centralized price feeds, initiate margin calls centrally, and centrally provide liquidity for their margin calls. Its examples include Celsius, Nexo, and BlockFi.

Degree 1 DeFi: There is a twist like these DeFi products are non-custodial but use centralized price feeds, initiate margin calls centrally, centrally determine interest rate, and provide liquidity centrally. For example- Dharma.

Degree 3 DeFi: These category of products are also non-custodial with permissionless initiation of margin calls, permissionless provision of margin call liquidity and the rest of the things are centrally administered. Think of ‘’MakerDAO and compound’’ as for example.

Degree 4 DeFi: These DeFi products being non-custodial have permissionless margin calls and provision of margin call liquidity and decentralized price feeds. The other remaining things are centralized.

For example- Fulcrum, dYdX.

Degree 5 DeFi: With permissionless margin calls, permissionless provision of margin call liquidity, decentralized price feeds, and decentralized interest rate determination, these DeFi products are non-custodial. But the platform developments & updates are centrally controlled. ‘’bZx’’ is an example of such product.

Degree 6 DeFi: Every single component in this DeFi protocol is decentralized and that is why there is no example of it.

Risk involving DeFi

Lacking of knowledge over adeptly handling cryptocurrencies and financial tools carry certain amount of risk. Users must be well-concerned about security factor like storing their keys securely. The 2016 DAO hack cautioned Ethereum community, DApp and Smart contract security about their security system. Following the incident, some DeFi tools went through security audits.

DeFi will keep you updated with changes in their products, wallets, exchanges, and crypto projects. Unlike traditional currency, the deficiency of extensive historical data and benchmarks makes it tough to assess the risk of investments in DeFi.

DeFi’s advantages

With DeFi, there is no need of any arbitrator in case any dispute and intermediary. A user has his full control on his fund and anytime he can do anything with that he wants. The data is recorded on the blockchain and spread across thousands of nodes as DeFi’s financial services are deployed on top of Blockchains. In that case, one is highly secure with his data as it is free of interference by others.

Basically there is no complexity in deploying a DeFi application because the system has been made so. DeFi rolled out its open hand to those who don’t have access to financial services. Low-income people can earn more with DeFi than traditional finance as DeFi cuts down the interference of any intermediary.

Potentiality of DeFi

Decentralized Marketplaces

Decentralization has made room for more financial innovation. Decentralization exchanges or DEXes are significant DeFi applications. These platforms allow users to trade digital assets without the need of any third party on a peer-to-peer basis. They allow trading with very lower fees unlikely to centralized exchanges. Another feature of Blockchain technology is that it can be used to issue and allow ownership of a wide range of conventional financial instruments.

Borrowing & Lending

Open lending protocols get the high priority over the traditional credit system considering the ability to collateralize digital assets, instant transaction settlements, no credit checks and many others. Borrowing and lending through this DeFi application is cheaper and faster and it reduces counterparty risk.

Monetary banking services

Stablecoins is usually pegged to a real-world asset which is transferred digitally with relative ease. A demand in creation of stablecoins has increased with blockchain industry getting mature. For everyday use, stablecoins can replace cryptocurrencies because cryptocurrency prices are highly volatile.

On the other hand when you are thinking of getting a mortgage, the process is lavish and time-consuming because of the presence of intermediaries and other parties. But when you are getting the same benefit with smart contracts, it’s quite easy, less-costy with reduced legal fees.

Role of smart contracts in DeFi

The creation of smart contracts is inextricably inlaid in many potential applications of DeFi. These smart contracts enable developers to build far more sophisticated functionality than simply sending and receiving cryptocurrency.

Reliable execution and automation of several business processes is possible with smart contracts as its terms are written in computer code, and requires no manual supervision. But, still there is risk existing with smart contracts which is with the damage of your computer, you can lose all your confidential data.

Hurdles to overcome

Prone to user error: As DeFi applications pose the responsibility on users deducting the involvement of intermediaries, there exist the risks of user mistake that can take place because of the lack of knowledge.

Low-grade performance: Compared to centralized counterparties, blockchains are slower as it translates to the applications built on top of them.

Bad user experience: DeFi applications should provide a tangible benefit that incentivizes users to switch over from the traditional financial system indeed. It requires much more effort.

Cluttered ecosystem: These applications are not suitable for all use cases rather than some. So, they should be built in such a way that these fit into the broader DeFi ecosystem.

DeFi and Open banking (Difference)

Open banking system runs under the rules of traditional financial system. In that case, people rely on a third party for the security of their fund and access to financial data through APIs.

DeFi is on the other hand an independent and entirely new financial system. It is because decentralized finance is focused on building financial services separate from the traditional financial and political system.

The emersion of DeFi

Approximately all DeFi projects are being built on Ethereum, establishing it the standard default blockchain for many dApps. Actually Ethereum is reigning over existing blockchains in amount of applications, user activity, trading volume, and application activity.  

Deficiency of true decentralization and healthy developer base are lagging other competitors far behind. Bitcoin focuses on security factor and Bitcoin’s most successful DeFi application is the Lightning Network, a smaller DeFi ecosystem, allows ultrafast and cheap payments.

Ethereum is staying at the perch because of advanced decentralization, programmatic flexibility and the enthusiastic developer base. DeFi project at present amounts to a substantial share of Ethereum’s ecosystem and the amount of Ether locked is collectively worth over USD 680 million. ETH and DAI is keeping DeFi ahead and Ether is needed to compensate for blockchain transaction fees and this currency is easily convertible to other currencies.

Core Benefits of DeFi

A DeFi is built on top of a blockchain, it adheres to decentralization. Let’s take a look over the core benefits of DeFi:

-In the absence of any third party, people regardless of social status around the world can participate in open finance.

-Speedy and low-cost transactions settlement is possible using this blockchain.

-DeFi makes sure a user is all in all of his own fund.

-Increased efficiency in the price and market as well as transparency.

-DeFi drives more and more innovation generating by uniquely combining different projects in layer 2 or even layer 3 applications.

What hurdles to pass?

There are some hindrances in the way to mainstream adoption and these obstacles are-

            -More and more innovation and technical experiments are required in the field of DeFi ecosystem. Its cryptocurrencies should be easily convertible to traditional currencies and vice-versa.

            -The liquidity is exceeded by centralized alternatives and liquidity is significant for efficient pricing in the financial industry. But, most of the protocols are failure to compete as efficient low-fee competitors.

             -Many products must be overcollateralized as there is no credit scoring or shared collateral, which shortens the leverage for professional traders.

             -Technical issues are hard to be detected as the system is new.

             -There exist several operational risks which are also obstacles.

             -DeFi poses a potential systematic risks taking birth from the interdependencies of DeFi protocol.

In addition to these issues, Ethereum itself has some issues that can cause problems to DeFi.

-Ethereum network can get congested on high usage time. These clogging issues can lead a transaction to remain in a pending state.

-Transactions with lower gas fees may be left pending at lower priorities.

-Interest and prices in DeFi are calculated per block and for bulky operation, a stable block mining is required.

But we see the similar issues of Ethereum existing on any blockchain. Such poor network performance is seen when there is high usage. But as maximum blockchains haven’t enough traffic, the scalability issue is hardly seen. However, it is expected that with maturity of blockchain and open finance, these applications will get way better.

DeFi Investment opportunities

Taking loan through decentralized lending is slightly different from traditional finance and it involves using smart contracts to hold collateral from borrowers and programmatically deliver interest to the lender. In DeFi, staking means the act of locking cryptocurrencies to receive rewards just likely to depositing money in bank in traditional finance.

Generally, with an eye to finding precious opportunities, DeFi investors typically leverage their unique thoughts. Interest in tokens supporting decentralized exchanges, derivatives, or other financial contracts like the Kyber Network token (KNC) can be seen. An investor can be mesmerized at the MakerDAO’s DAI stablecoin project.

Things to know before DeFi investment

Keep these following things under your considering before making DeFi investment:

Make research

Before making investment on DeFi, just check out whether or not it is a scam and to know it Google the name of the project along with the word ‘’scam.’’ With open-source technology, anyone can view the code used to operate DeFi tokens and protocols.

Saying of other people

DeFi projects put their smart contracts off manual security audits from reputable security auditors like Quantstamp. It is they do to keep their security at the perch. Through several forums, and social sites, one can know the view over security of DeFi project from other people and the project’s team members. It isn’t a useful way that a person goes through the project’s website to match their information up with that information earned from communication channels moderated by the project’s team members, because it is failure to show the real face of the project. It is hard to judge the information you have obtained isn’t a paid advertising.

Is the contract verified on Etherscan?

Verification of a contract on Etherscan makes sure the code can be publicly evaluated without the fear of the code being changed in some crooked way. But there is no room to think that this verification keeps the smart contract away from scam or other vulnerabilities. People can report any suspicious activity though the ETHProject of Etherscan.

The issue of bait and switch

Bait and switch is deemed to be a fraudulent sales tactic that attacks customers in with specific claims about the quality or low prices on items that turn out to be unavailable in order to upsell them on a similar, pricier item by definition. Many DeFi project do the same thing like they mint ERC20 tokens to support their operation but hiding among these tokens are a copious of shitcoins and scamtokens with the intention to lure in investors so eager to get in early they are intent to invest without investigating what the token does.

Things to avoid

Invest according to your ability 

Do not invest more than you are intent to lose in DeFi tokens and protocols. It is because there is high possibility of losing as the space is too novel. Investment in decentralized technologies can be lucrative on occasional basis. These emerging technologies are high-risk opportunities for an investor.

Don’t get caught slippin’

When you are going to invest a significant amount of money into digital assets, its security is a big factor. To keep your digital assets in a safe place, you can buy a hardware wallet from any reputed brand.

Can DeFi bring a revolution in finance?

The services DeFi is offering -borrowing funds, taking out loans, depositing funds into saving accounts, and trading complex financial products- is mesmerizing people. DeFi ensured borrowing of money via smart contracts and made the contract obliged so that no one can change it. A recent assessment showed that the amount of money locked into several DeFi services has exceeded $2 billion.  DeFi services are simple to use indeed.

Tokenization of Everything

Crypto tokens reside on their own blockchains represent an asset or utility. Tokens are smart contracts themselves. Tokens on Ethereum share many properties with Ethereum’s currency, namely ETH or ether. But properties can be developed in conformity with certain financial products and services. A number of financial products have been tokenized on Ethereum over the last few years.

Creation of complex products is possible and allowed by smart contracts. As an example, you go to a decentralized cryptocurrency exchange and purchase sETH, which is a short position abstracted in an Ethereum token built on the dYdX protocol. It’s a process of sorting ETH for that one needs to generally sign up at an exchange, transfer some money there, and performs certain actions. The sETH include all the steps into a token that you can buy and hold in a cryptocurrency wallet. It is really easy to sort ETH as sETH has a contrary relationship with ETH like it’s value goes up when ETH goes down.

DeFi: A new Bubble

A high rising interest in DeFi products and services has been seen, and some of it has the makings of a bubble. Some frictions existing in present finance have been come across by DeFi products. People here have the freedom to create them and place them on the market, with no oversight. DeFi has been also offering high returns on their lending products. There is a site namely DeFi Rate listing the lending interest rates for DeFi products.

Vitalik Buterin, co-founder of Ethereum, told higher returns are never free of risk. Compound, one of the DeFi services, led to a boom launching COMP token back in June where users who provided liquidity to various Compound services would earn the COMP token as reward. Compared to traditional finance, the interest rate is very much higher in DeFi lending platforms.

DeFi stands for decentralized finance and it is permissionless. The fiat currency in a country you are living has a fast-increasing rate of inflation. In that case, you could turn your money into a U.S. dollar-backed stablecoin and get a high return rate on top of that.

Walk along risk

DeFi is leaving opportunities to 1.7 billion unbanked adults and these opportunities range from simple savings products to complex trading platforms. DeFi offers certain products in a cheaper rate cutting down middleman. DeFi is offering its services with less friction.

For being useful to average people, DeFi services have some hurdles to overcome. As speculation is the basement of these services, there is inherent risk. The space is yet hazardous because of the immaturity of smart contracts, high volatility, and the possibility of miner interference.

Why people are so hyped about DeFi?

DeFi or decentralized finance has unfurled people with the opportunity to recreate traditional financial instruments in a decentralized architecture, deducting the interference of any company and government. Bitcoin and Ethereum being the original DeFi applications are controlled by large networks of computers. Ethereum is assisting startups to crowdfund their operations and Bitcoin is being used as a store-of-value investments by many investors.

The arrival of ‘’stablecoin’’ Dai is working as a bar to the way of Bitcoin for everyday purchases. Its value is pegged to U.S. dollar and drastically reducing volatility. Compound helps users earn interest.

DeFi basically aimed at reedify the banking system for the entire world in open and permissionless way. DeFi has gotten popularity because they have a libertarian streak and they are able to build censorship-resistant products. In this fragile financial system, only decentralized financial application can make our financial system more transparent, more resilient.

Take the example of Venezuela which has seen a steep drop in their oil price and their economy has got crushed because of poor government policies like printing large amounts of money. Venezuelans are now using digital assets to fight hyperinflation. In that case, a small number of people are using Bitcoin to shield against inflation and to send money to family members living in other countries.

With 21,000 people adopted Dai, it hit a peak number of daily transactions at 13,490 leading the stablecoin to be one of the popular ones. Dai’s software is technologically very complex which consists of more than 1,000 lines of code. About $339 million, two percent of all ether, worth of ether is locked up in Dai and in case of Compound it is $34.

On the other hand, another stablecoin Tether has crossed 44,000 transactions on April 4, which proves this one has much more usage. There are notable use cases of Dai like it is assisting residents of troubled countries. But, even after so many use cases the issue of hacking is a threat to DeFi applications. There is more promise in a stablecoin which is created by a large company with many users like Facebook.

Financial Risk in DeFi

People by born have an inclination to head toward such an investment where they are gainer. Attractable interest rate, extensibility of decentralized finance, lending products with superior interest rate has led DeFi to become an attractive source of investment. It is thought that captivating returns offered by DeFi probably take root from systematic risks.

Arguably, lending Dai to Compound or dollar to the U.S. government in the form of 10-year treasuries involves the same dynamic but where the 10-year Treasury bond is taken as a secure investment, another one is a new opportunity. Although risks are inherent to Dai, no rewards come without the involvement of risks.

Risk in DeFi

By definition investment risk can be defined as the probability or likelihood of occurrence or losses relative to the expected return on any particular investment. Before making investment, any investor should consider the systematic risks associated with the investment. Risk varies on the basis of investment product and the investor’s hunger like how much he is willing to take on in pursuit of a reward.

If someone wants to have more return, he must take high risks. Specialized knowledge over using and obtaining cryptocurrency in the authentic manner is required in DeFi. But when you are ignorant of it, it carries a good amount of risks to the investor. DeFi investment is interesting to those who has high-risk appetite.

Insecurity of smart contracts

There is still skepticism about security of smart contracts as it faced hacking issues several times. Hackers can snatch away cryptocurrencies, as they get deployed to various networks. Though companies like Nexus mutual are coming with the opportunity of insurance to suppress such problems, but these are not any reliable solution indeed.

Developers are coming with several new steps to maintain security like using a hardware wallet, multi-factor authentication, and keeping your holdings a secret etc.

Various cryptocurrency projects are running with updated protocols and changing terms of service. These changing terms are being applied to cryptocurrency projects, digital wallets, and exchanges. Some DeFi products introduce a new dimension in that they have been paired with DAO’s that rule certain aspects of a platform or protocol.

Financial Risk

Investors make analysis over historical data and benchmarks and risk-free rate of return to evaluate investment opportunities. Whether the return is guaranteed or not that depends on this analysis. But this analysis can be done in traditional finance, but it is impossible when it comes to DeFi due to the lack of comprehensive historical data and benchmarks.

Is DeFi Ethereums Killer App?

The real use case of smart contracts is yet to know. The ICO has enabled easy fund raising with blockchain. But, a huge portion of the funds raised were traded for network tokens which may hardly have value in future. You can take the example of Bancor which raised nearly $150 million for a token exchange protocol. The Bencor token works cross-chain on EOS, Ethereum, and POA Network.

In that case Uniswap is slightly difference but the protocol is same like they created a protocol on a single chain by a single developer, without creating a token to transact, and without raising millions of dollars. These two protocols are different with different goals and there is also no direct competition between them.

Then you can think of protocols like Maker/Dai, Compound, and DYDX that allow you to have the same kind of leverage.

Decentralized Finance

Maybe, DeFi will replace current financial system with open-source protocols after few years down the road. Will DeFi be able to truly do so within few years? Yes, you have confidence in your thought when you think of the quick revolution of the Internet Disinter-mediated traditional media which is driving the business of newspaper.

A number of DeFi protocols and projects are on the ground, but only some of them are successful by some metrics and the remaining is yet to make money. We are yet confused if these handful successful projects have led to the hype. Some DeFi projects like Compound, Uniswap and DYDX are walking with the intention to creating suite of smart contracts that lock up ETH and tokens, effacing the necessity of any network token.

Compound Finance

The Compound is a notable one out of several Ethereum projects. The strategy of Compounds smart contracts is alluring and can make profit in the future.

No protocol token

Compound has decided to come out of token last year thinking it will enhance complexity. Among other problems of token, two mentionable are it has some legal problems and some of them end up being identified as securities.

The necessity of tokens appears providing that the network is large. So, Compound thinks it has no good reason to have a network token.

Protocol Fees

Compound protocol makes money charging a small fee to the engagers so does the financial industry. A small fee of 0.25% isn’t a big deal at all. Charging a small fee will lead Compound to build a transparent, public, and globally available money market. A layer of trust will be added to their platform once they are able to build a brand around the company.

Simple implementation

You can easily understand the goal of the Compound protocol through reading their whitepaper. Users need to interact with the protocol’s 5 main functions that include supply, withdraw, borrow, repay, and liquidate.

Beginners can easily grasp this simplicity. The easy-understandability makes it easier to allure open-source developers to build on top of your protocol, as the ease at which the code can be read is significant in open-source development.

Strategically Decentralized

Here the strategy is keeping the code proprietary up until the last moment, and edifying a proprietary interface in parallel. Then the release of the platform is done and commences alluring users and establishing the brand and trust of the company. It makes sure no one can fork the code and launch right beside you.

The next part of the strategy is returning to the drawing board upon the release of a new version of the protocol. At the official release of V2 on mainnet, they will start building out V3 with newer features. It keeps them few steps ahead of anyone attempting to fork their protocol.

Building DeFi products rather than entire blockchains

Thinking building a blockchain is so difficult, Compound is working towards designing the best smart contract money markets in the globe. A DeFi product can be easily created on any smart contract platform. Many of the blockchains will fail is the reality indeed. You can keep your brand, and your web interface, and change the blockchain it runs on top of with a DeFi product.

The popularity of on-chain lending may drive traditional secured lending and proof of stake consensus to be disrupted. Proof of stake (PoS) is a type of consensus algorithm by which a cryptocurrency blockchain network aims to obtain distributed consensus. Basically Proof of stake (PoS) is an alternative to Proof of Work.

In case of security, the PoS network is secured enough when there are lots of coins actively staked for the network. Honest actors own 2/3rds of all the staked assets in this algorithm.

There are two ways of running attack through one is an attacker has to pile up 1/3rd of all of the outstanding stake and another is they can convince the current set of stakers to stop staking and then take over the much cheaper network. If an attacker wants to implement the second approach then he needs to offer them more attractive yield elsewhere. On-chain lending markets directly vie with the protocol being secure.

Simulating staking games

There is a technique which is known as agent-based simulation through which modeling a complex economic system is possible. In this technique, a huge number of agents are modeled with a variety of strategies and risk profiles and let them loose on each other. One can have the statistical confidence observing the way of behaving by the network in different scenarios through watching how the emergent system amplifies.

In that case the notable thing is that PoS chains are unable to safely utilize deflationary monetary policy. Another point is, upon the decrease of PoS block reward over time, its long-run equilibrium will be for almost all assets to be lent, not staked.

Attacker’s step

With an eye to dominating and driving stakers away from staking toward lending, an attacker needs to subsidize an on-chain lending market and pay a better long-term rate.

In Compound, the attacker keeps borrowing which leads to the rates for lending increase. As a result more and more stakers transition into lending, and thus the security of PoS gets dripped on a gradual manner.

Seers want to go short ETH observing the total stake drawing back which drives the borrow demand on Compound to increase over and over. Attackers have to put up collateral to borrow assets in Compound to do this.

One thing to learn here is that at the time of attacking the network the attacker can have no price exposure to ETH in case the collateralization is done with USDC. An attacker is able to run this attack in PoS while hedging out all their price risk all on-chain.  

Protection of PoS systems against this

Through forcing on-chain lending markets to cap interest rate or vying with the lending markets by offering better returns to stakers, a staking network can fight this. As an attacker is well known of how much they need to subsidize the lending market for cannibalizing stakers, it’s a rational way to use flexible monetary policy to offer competitive rates upon necessary. A PoS protocol must have adaptive monetary policy to remain secure in eternity. Ethereum hasn’t committed to any fixed monetary policy which has given it a strong footing.

Impact of DeFi

When you start thinking of the impact of DeFi, the first thing that leaps up to you is stablecoins. It is expected that stablecoins are ahead of Bitcoin in the case of enveloping the whole financial system. DeFi is establishing a financial system in a decentralized manner but regulators can hardly understand DeFi apps. According to regulators, stablecoins convey certain amount of systematic risk to global finance. But authentically, stablecoins pose no risk for governments but the risk of a stablecoin user depends on when he relies on counterparty. Stablecoins like Libra is no different than cash but regulators don’t know how stablecoins work actually.

Regulators are pleased with Libra in one case which is Libra can control everything with Libra like tracking every single transaction, every wallet, and every owner. Libra is backed by a basket of fiat currencies.

DeFi and the dollar

Think when you are using a credit card, credit is usually issued, but when it comes to Libra, no credit is created. Facebook backs the token holding the dollars with a bank. In that sense, the risk credit card is posing on the economy is less when comes to Libra.

A risk stands that Libra issues more tokens than the assets it holds in reserve. In case the association goes belly up, it could lead to people losing their money. But this is very unlikely to happen as Libra is not based on a fractional-reserve system. Another risk appears which is the Libra association or bank holding Libra’s assets implode. But this risk doesn’t cover a large area so it doesn’t pose a large threat to the global financial system.

DeFi and stablecoins

As regulators don’t have sufficient understanding over stablecoins, they are intent to block Libra. It is thought that their poor knowledge over the space will slow innovation. Regulators have the same mind setup as they had over Bitcoin. If gold doesn’t pose a systematic risk then neither does Bitcoin. People can trade more efficiently with stablecoins than international bank transfers and if Libra is regulated, it will provide systematic stability. A high decrease in fees with DeFi can probably make a space for it ahead of bank.

Necessity of advisors as Decentralized Finance is approaching

As we know financial institutions become successful on their role of middleman charging fees, but DeFi is going to engage them on a peer-to-peer basis meaning it will make financial functions decentralized. This transformation of financial services will be happened with the hand of decentralized finance or DeFi.

DeFi makes sure financial services should be controlled by and for those who enable institutions to earn large amount of profit through allowing them to use their money in banking, trading securities, and providing insurance. All regular financial activities are being done using blockchain technology applications like online shopping, paying household bills, trading securities on OX, buying insurance through P2P pools over Etherisc etc using cryptocurrency instead of fiats.

DeFi gives rights to clients to manage assets on their own which can lead to its high use in the next five to 10 years down the road. People will hardly need advisors in general as indicated by DeFi’s DIY potential. One day living in the centralized services probably will be a matter of taunt.

It’s not a big headache to those advisors whose careers are at the brink of termination. But mid-career practitioners need to know following things for suggesting an urgent need:

-Earning complete knowledge over the current and developing blockchain applications.

-Learn about the actions to be taken based on likely impacts.

-Consumers need to have advisor for adhering activities of DeFi like for assessing risk/return, understanding new assets, but not for trading in tokenized assets.

-As DeFi leaves the control on the respective investors, they need a well-versed advisor to properly tailor their investment holdings to their desired lifestyle.

DeFi Interoperability Solutions

Fusion, Cosmos, and Polkadot are three projects which are expected to play a vital role in tomorrow’s blockchain space. They are not only having development platforms but also specialized in interoperability.

We will briefly discuss about these three projects in the below which will help you make the authentic decision when adding DeFi projects to your investment portfolio.


Fusion with a goal of placing blockchain technology at the center of global finance has its patented DCRM technology and some other unique technological concepts. Through these technologies, it offers interoperability based on cryptography. The name of the CEO and founder of fusion is DJ Qian.

Fusion has applications on different scales because of these technological tools.

-On a small scale: Communications and exchanging of data and value is possible here because of the interoperability among blockchains.

-On a large scale: The Fusion ecosystem has the potential to be used in the case of Smart cities through enabling blockchain applications to operate any traditional financial operation.


Cosmos project has been developed with an eye to linking different siloed blockchains. Cosmos is made up of Tendermint core, which ensures the same transactions are recorded on every machine in the same order, and a blockchain development platform called ‘’Cosmos SDK’’, which is a framework that facilitates the development of secure state-machines on top of Tendermint. Through the Inter Blockchain Communication (IBC) protocol, Cosmos is hoped to make sure interoperability of its network.


Rising of $145 million through ICOs in 2017, Polkadot appeared with the promise of interoperability. Polkadot allows the transfer of data and value between the different blockchains of its ecosystem. The technical team, which is led by Ethereum co-founder Gavin Wood, of the project is quite dedicated to the goal. The team is trying their level best to make the platform developer-friendly.

Spread the love

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top