What is DeFi?
DeFi is a decentralized financial systemoperating on a decentralized network, eliminating intermediaries and making many of the financial products offered on the system more efficient and economical.
Why is DeFi necessary?
First of all, we need to analyze what problems the centralized financial regime encounters.
Concentrated finance has a rather high interest rate
When you want to make mortgage loans, the average interest rate can be up to 7-8% per year at most banks.
But with a peer-to-peer mechanism, network participants can “compromise” directly with each other. As a result, the middleman’s operating costs will be reduced and loans will have lower interest rates.
Financial focus requires certification papers
Licensing as well as certification is a complex issue with a centralized financial system. When you go to the bank and want to make loans, the paperwork will be quite annoying. Besides, there are loan packages with high requirements that make it difficult for many people to meet mortgage standards. This is understandable because in order to strictly manage the lending stage, banks will have to have framework sanctions.
In contrast, with a decentralized organization and operated on the blockchain, all information will be automatically recorded, you will not need to ask your credit certifier, and be able to receive loan packages. convenient and more suitable.
Centralized finance has individual impact
2008 is a prime example of the management weaknesses of a bank’s current credit system. Some bad debt or overlapping debt problems can occur with traditional financial systems. This is due to the impact of the censor of the loans. But with the decentralized network, all loans will be specified in smart contract terms, minimizing the impact of human factors, thereby helping the network operate by itself without having to stand in the middle to manager.
- Permissionless: Participants will be equal and do not need to register with a complicated procedure.
- Transparent: Human-influenced elements can be restricted because all activities on the system are recognized and made public.
- Low cost: Because there is no unit above all, all costs will not go through a 3rd party and will be reduced significantly from there.
Products in the DeFi ecosystem
Many people think that DeFi only has lending activities (lending) from MakerDao with Dai (or now Sai dong). However, DeFi’s network is much broader than that. Here are some of the products that grow in this ecosystem.
Some of the assets currently in development are probably too familiar to everyone. That is Bitcoin, Ethereum, the cryptocurrencies that take blockchain as the foundation. These types of assets will have flow transparency, users can track the transactions taking place between wallet addresses.
There is one type DeFi property Stablecoin is quite special. These are cryptocurrencies that are pegged to an asset class such as gold or fiat money held in a storage fund. Normally, with fiat currencies, stablecoins will be pegged at a 1: 1 ratio with that fiat unit.
Derivative, lending and insurance with DeFi
Derivative though is quite common in traditional financial activities, however, this type of product is still quite unfamiliar to many people if applied on a decentralized network. So what difference do these products have in performance?
First of all derivative contracts will be applied to these DeFi property stated above. Next, this system will provide a transparent and clear product for investors to receive more information. Data from DeFi Pulse shows that the amount of money detained in DeFi derivative products has been on an increasing trend.
Lending activities on DeFi are receiving a lot of attention in the current community. MakerDao is one of those systems that stands out with its pretty innovative model.
DeFi lending solutions will usually be based on a decentralized autonomous organization (DAO), which is a self-operated organization thanks to the blockchain network. Rules for transferring assets and operating on the network will be decided in smart contracts. These specific smart contracts are called CDP.
A specific CDP is a smart contract, prescribing a maximum rate of mortgage and assets that you can withdraw. For example the minimum ratio for MakerDAO is 1.5. This means that if you put in $ 150 ETH worth of money, you can only borrow an asset equivalent to $ 100.
Besides, there are models like dydx and constant with semi-decentralized model. You can follow the detailed analysis of these models in the attached CHK articles.
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However, because it is collateralized by many digital assets, the risk of price fluctuations is still quite high when participating in these lending models. Therefore, the DeFi system also develops an attached product that is insurance. These products are also regulated in smart contracts to ensure consistency with the supporting platforms they support. Typically, we can refer to the name Nexus Mutal. Users can buy these insurance packages for protection in case of fluctuations or security holes occur.
With these types of DeFi non-custodial wallets, users will be able to actually own their assets without having to be kept by a third party. Popular types of wallets on the market include:
- Coinbase Wallet
Besides DeFi wallet, the current market has an additional type of wallet, a smart contract wallet with improved features such as allowing you to freeze your assets when there are signs of suspicious or cost reduction.
DeFi decentralized exchange
If with centralized exchanges, assets will be concentrated in one wallet, or if with careful exchanges, it is possible to create many different wallets. However, in general, this model still concentrates a quite large amount of money in one place and the risk of attack is high. So how does DEX (or Decentralised Exchange) fix that?
Users do not deposit money into the exchange and trade with the balance recorded. Instead, the number displayed on the wallet screen is the actual number of users. The amount of coins will be distributed everywhere and minimizes the risk of attack. Some exchanges that are following this model are Bancor, AirSwap and KyberNetwork as well as Binance DEX.
Below is a summary of the category of product types: Issues, Transactions and Ownership (or add-on products).
Challenges of DeFi
The value to bring has not been determined
Most of DeFi users are for arbitrage trading to make a profit through exchanges as well as in the form of margin. This makes DeFi quite separate from many applications in the real everyday financial environment.
Costs for DeFi activities have not really been minimized. DeFi prides itself on low costs but due to the sharp price volatility of collateralized coins. And if the loan contract is liquidated, the user will have to pay a stable fee ranging from 11 to 13%.
Too many applications on the market
As you can also see in the overview above mentioned, there are too many applications exist in the DeFi field at present, which will give people more options. However, it is this redundancy that makes users a bit confused about the applications and their features. The brands have not clearly defined their differences so that users know what service to choose.
As mentioned above, the wallet is decentralized, so the possibility of an attack is there and if the problem occurs, no unit will come forward to solve it.
For example, the lending model, because the price is anchored in cryptocurrencies, the stablecoins are created, if continued to be pumped around as collateral, can create a virtual amount of value.
The DEX exchange currently does not have a large volume because users are quite skeptical about the security and safety. Binance himself did not stand up to guarantee the responsibility for Binance DEX, so it is understandable for users to trust centralized platforms.
Low liquidity and the speed of processing transactions on DEX is quite low compared to centralized exchanges. Besides, the technical stage of lending is still limited, so the processing speed is still quite slow.
DeFi’s future potential
Cash flow into DeFi increased over time
As mentioned in the DeFi products section, we can see that the amount of ETH confined in the DeFi system continues to increase.
When ETH shows signs of decline, the amount of capital poured into this asset gradually increases so that ETH can be locked up in DeFi. This is how investors can benefit from both future ETH selling prices and interest rates.
The statistics show that the DEX floor volume shows signs of increasing, the amount of detention in loan applications also tends to go up, but will this trend last in the future?
More assets can be deFiised
In addition to many existing products such as securities or insurance, DeFi services can provide a variety of services for real estate or even platforms to support intellectual property.
DeFi is expected to be able to shift people’s interest from trading to more specific applications such as lending or system management. However, this expectation still needs more test in the future.
Summary What is Defi
- DeFi is a decentralized finance, providing financial products without an intermediary to minimize many delays.
- DeFi has many products, divided into 3 main areas: assets (financial instruments), transactions and supplementary products.
- DeFi is a potential solution that can tackle the existing problems of centralized finance. However, there is still a lot of work to be done for this form to bring more applications and convince users.
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