BigONE View: In-depth analysis of the five advantages of DeFi
Since 2019, DeFi has been a long-term hot topic in the blockchain area, and platforms and businesses that provide DeFi services have grown rapidly. DeFi is regarded as a “new financial revolution,” so what is the essence of DeFi? What are the advantages? How does decentralized lending work? What are its innovations and weaknesses? Where are the opportunities to be found? Today, please follow BigONE’s perspective to assess DeFi projects thoroughly.
What is DeFi?
Decentralized Finance, also known as Open Finance, is abbreviated as DeFi. It really refers to a decentralized protocol used to construct an open financial system that aspires to allow anybody in the globe to perform financial transactions at any time and from any location. Financial Services in the current financial system is mostly supervised and regulated by the central system, whether they be the most basic deposit and withdrawal transfers, loans, or derivatives transactions. DeFi wants to develop a transparent, accessible, and inclusive peer-to-peer financial system through a distributed open-source agreement, reducing trust risks and making it easier and more simple for participants to raise funds.
Advantages of DeFi
There is trust in the system, everybody has access privileges, and there is no centralized control.
DeFi’s protocol is entirely reliant on the blockchain for corresponding development, and it may adhere to blockchain technology’s highly transparent and non-tamperable qualities. In other words, the particular terms of these agreements and the movement of payments are visible to everybody. You can plainly see any circumstances of the agreement’s operation as long as you look at it, and the agreement cannot be changed at any time. So, when we use the DeFi protocol, we don’t have to worry about the faults of centralized organizations. This is also a technical feature of the blockchain itself.
With low transaction costs, individuals with asset management needs can rebuild on machines and codes without trusted intermediaries.
With low transaction costs, individuals with asset management needs can rebuild on machines and codes without trusted intermediaries.
DeFi’s natural transparency does not require access, open-source, or free combination, and we do not need to promote DeFi or decentralized finance. Traditional finance has been evolving for hundreds of years, and it has resulted in a very complicated, sophisticated, and costly system. While the 2008 financial crisis can be seen as a growth of traditional finance, it also highlights many of traditional finance’s shortcomings. For example, it is already extremely convoluted and is no longer understandable. For example, the financial market, the derivatives market, and the transaction structure are exceedingly complicated, as evidenced by the crisis. The regulatory agency as a whole and traditional financial institutions are exceedingly complicated, and the cost is prohibitive. Compared to traditional finance, the threshold is high, the transaction cost is high, and even the handling charge problem in the transaction process may be solved well in DeFi.
Resistance Against Censorship
The term “anti-censorship” refers primarily to the fact that once the debt repayment arrangement on the chain is opened, it will immediately operate and continue to run for 24 hours. It cannot be stopped or terminated by the government or any other body. This is also a feature of blockchain technology itself.
Security
Whether it is in the DeFi field or the traditional Internet, it will almost certainly be attacked by hackers as long as it is a program. DeFi is essentially an open-source protocol with open-source code. Because many people come to uncover its problems and then aid it to make corresponding improvements, its security is still higher than these non-open source software. This security is even higher when combined with the features of the blockchain.
Ecological
Everyone may use the term DeFi Lego when discussing DeFi. What exactly do you mean? It is a non-repayable arrangement, such as a loan agreement or a transaction agreement. Each agreement is like a building brick, and these building bricks can be freely joined to create a range of new financial agreements. Because all DeFi agreements are open source, anybody can collaborate to create new financial products and accelerate financial innovation through the network effect. To illustrate its ecological character, we may envision that as more and more financial basic protocols emerge because it is initially open, you can call them whenever you want. As a result, for the time being, the DeFi protocol can be used totally.
What is decentralized lending?
Background of decentralized lending
For enterprises, both institutions and individuals have thresholds and standards for traditional borrowing. Both the real market and the cryptocurrency market need new financing tools and methods. For mature financial markets, richer financial instruments will bring higher market liquidity. It is foreseeable that decentralized lending is an important step in bringing cryptocurrencies into financial services.
The problem of centralized lending is credit. If the credit is high enough, you can borrow more, and vice versa. For example, you can take a loan if you study well. If you pay more tax, you can take out a loan. If a company has fixed assets (factory, equipment, patents, antiques, gold, etc.), you can take a loan. However, the legal and financial risks associated with these matters are very high, and the problems cannot be solved in a long and stable manner. It is said that the blockchain solves the credit problem. How to solve it in the lending business? The answer is decentralized lending.
Decentralized lending attributes
Decentralized lending refers to matching the borrower and lender through a decentralized lending agreement and then transferring assets quickly after confirmation of the mortgage and pledge to complete the lending behavior. The decentralized lending protocol provides the platform with a technical basis for standardization and interoperability and plays a role in security management in the loan process.
Compared with the traditional lending model, the decentralized lending model has the following attributes:
Combination of legal currency loans and digital asset loans;
Mortgage based on digital assets;
Realize real-time transaction settlement through automation and reduce actual costs;
The mortgage model is used instead of credit review, which means that more groups that cannot use traditional services can be served.
Three models of decentralized lending
- P2P matching mode
Take Dharma and dYdX as examples. Both are peer-to-peer contracts that match both borrowers and lenders.
In the Dharma agreement, the smart contract acts as a “guarantor” to evaluate the asset price and risk of the borrower. The creditor decides whether to lend to the borrower based on the evaluation results provided by the “guarantor”. At the same time, when the borrower is unable to repay the loan on time, the “guarantor” automatically executes the liquidation procedure.
The dYdX protocol is also a P2P model. Still, the main difference between it and other lending platforms is that dYdX also supports other transactions besides borrowing and lending, such as futures trading. When a trader opens a position on dYdX, he will borrow a margin and reach an agreement with the lender on the terms and conditions through the platform to conduct margin trading. Therefore, dYdX’s target customers are mainly margin dealers. The interest on the dYdX platform is variable, and there is no lock-up period or maximum period when users borrow on dYdX.
2. Stable currency model
The typical model of this model is MakerDAO. There is no lender, but only a borrower and the only asset that can be borrowed is DAI. Borrowers borrow newly created DAI by collateralizing digital assets (now ETH). DAI is a stable currency pegged to the US dollar issued by the MakerDAO platform. The pledge ratio of pledged assets and loans must be kept above 150%. The interest is global and is determined by MKR holders through voting. Interest is not stable and has risen from 2.5% to 19.5% in more than a month.
3. Liquid pool trading
Taking Compound as an example, borrowers and lenders trade through a liquidity trading pool instead of matching counterparties. The lender can deposit funds into the loan pool to earn interest continuously and withdraw assets at any time. The interest rate of each loan and borrowing is determined by the liquidity of the pool, which fluctuates by the ratio between the total amount of money provided by the lender and the total amount demanded by the borrower. Compound does not set a fixed loan period. The borrower has an unlimited contract period.
Five areas of DeFi applications
- Stable currency assets
USDT is undoubtedly the largest stable asset, but there is an assumption here that the issuing company of USDT has enough U.S. dollars to accept. That is to say, USDT is actually a centralized asset. And many mathematics experts and computer experts try to use the concept of decentralization to develop stable coins. This is the core of DeFi, but without a stable foundation, everything becomes so unreliable.
2. Oracle
An oracle is a fictitious trusted entity that can write information outside the blockchain to the blockchain. We are mainly used to grab the price of digital currency to predict the price on the chain.
For example, A is a professional farmer, and B is a food producer. A and B want to exchange livestock and food, but the prices of livestock and food fluctuate, so they need to inquire about the price of others to exchange. Inquiring about price information is the main function of the oracle—the better the efficiency and structure of the oracle, the fairer the exchange between customers. The oracle is the bridge between the blockchain and the real world, which plays a role in communication and promotion.
3. Decentralized exchange DEX
Traditional exchanges require accounts, passwords, and verification codes to log in. Customer asset data is stored on the server and performs centralized asset custody, while decentralized exchanges are blockchain-based exchanges. The asset data is stored on the server, but the smart contract is directly used for chain transactions, and the asset is always in the customer’s personal wallet. The main representatives are Uniswap, Balancer, and Curve.
4. Mortgage loan agreement
The decentralized lending agreement matches both borrowers and lenders and transfers assets immediately after the mortgage is confirmed, completing the entire lending behavior.
5. Synthetic assets
Synthetic assets are financial instruments that simulate other instruments. In other words, any financial instrument's risk and return status can be simulated by a combination of other financial instruments, and synthetic assets are composed of one or more derivatives.
The development and future of DeFi
The transition from the bank account to a non-custodial wallet
Cryptocurrency wallets will serve as the infrastructure for future DeFi applications. Due to cost and ownership reasons, non-custodial wallets are more favored by the cryptocurrency market than custodial wallets.
Algorithmic currency market-mortgage loans and borrowing through everything
Due to the outdated SWIFT payment network, KYC procedures, and manual methods, the traditional money market has caused serious inefficiency in capital allocation. The algorithmic collateral ratio enforces the rule that the balance of each account must exceed the outstanding loan amount to eliminate transactions. Counterparty risk.
Synthetic assets are an untapped derivatives market
Synthetic assets are an important cornerstone of DeFi market infrastructure construction and a key component to mature and increase the breadth and depth of liquidity. Synthetic assets are expected to reduce original costs while eliminating counterparty risks in the derivatives market.
About BigONE
BigONE is a global cryptocurrency exchange that provides a platform for trading various cryptocurrencies. It was founded in 2017 and registered in the Netherlands. The group operates in Russia, Brazil, Vietnam, Seychelles, Singapore, Japan, and Indonesia, providing marketing, investment, and blockchain technology research & development.
