The Present State of DeFi
An authoritative understanding of the present state of Decentralized Finance.
Abstract 🏦
Since its very inception, Decentralized Finance has revolutionized the Global Financial system, introducing transparency & Simplicity to the pre-existing Opaque & Complex Global Banking System. DeFi (Short for Decentralized Finance) is perhaps the future of monetary services and will hold significant Economic Value. Let’s understand how the world of DeFi Functions & what stage is it currently at. We’ll explore various Protocols & Networks shaping this world.
What is DeFi🧐?
Decentralized Finance, as the name suggests is an Open & distributed Umbrella of various Projects providing services like Lending, Staking, Borrowing, etc. It sounds very similar to what present-day Banking Systems do, but the difference here is, there are no intermediaries. There exists no centralized system like Banks, Brokerage or Government Bodies, instead it is Smart Contracts on the Blockchain that dictate the terms of Financial Agreements. In its essence, DeFi relies on 3 key Technologies :
How does DeFi Function🛠️?
As mentioned above, DeFi leverages the distributed ledger like Structure of Blockchains to record transactions. Cryptography is used to secure and encrypt these transactions and prevent fraud, while Smart Contract which are simple programs that run when pre-determined conditions are met, they determine when and how a Transaction takes place. The interplay of these concepts enable all of the present DeFi Platforms to function.
When you make a transaction in a centralized financial system, for instance if you withdraw $100 from your Bank account, a private ledger operated by your Bank stores the record of this transaction. They or any other unauthorized entity may tamper with these records, manipulate them or erase them! In DeFi, such a record will be stored in a decentralized manner, all participants will have a Cryptographically secured record which if tampered with on one end will still remain authentic all across the network.
Why is DeFi required🤔?
Believe it or not, our Centralized Financial Institutions like Banks or Brokers run the entire financial system; a regular participant has to deal with these bodies to access services like Loans & Mortgages. DeFi believes in the principal of eliminating the middle-men, providing access & authority to the users directly. It eliminates the need for centralized Authority to regulate and benefit from your activity and instead builds a self-reliant & democratically regulated Ecosystem for the entire process to become transparent. Here’s a simple example to illustrate the difference DeFi makes :
Alan deposits certain part of his Salary in his Savings Account. The Bank provides him a 0.5% interest on this money. The Bank lends that money to Borrowers in form of Loans. Here the Bank charges 3% Interest rate and the remaining 2.5% is the Bank’s profit. In a DeFi scenario, you can use Lending Protocols like Aave or Compound and lend this money directly to borrowers and earn 3% interest on that. Blockchain eliminates the need for Banks to act as middleman & earn its cut. The user is empowered.
History of DeFi⌛?
The History of DeFi truly begins with Satoshi Nakamoto launching the very first Cryptocurrency in the world, “Bitcoin”. The potential of Blockchain & Decentralization inspired various other creators across the world to leverage this technology to build Platforms & Services. ‘SCRIPT’ was the Language with which the Bitcoin Blockchain was developed, but it wasn’t sufficient for building DeFi Applications. This is when Ethereum came to rescue. ‘Solidity’ was the Turing-complete programming language used for building on the Ethereum Blockchain with the ERC20 Token Standard. It became the go-to platform to deploy Smart Contracts and build DeFi applications.
One of the very first platform to emerge was ‘Maker’, a decentralized protocol to launch stablecoins on-chain and escape the volatility of Cryptocurrencies. Several other successful protocols like Aave, Uniswap, Kyber Network, Compound, etc. emerged from this phase. Several interesting concepts like ICO(Initial Coin Offerings), Yield Farming & Incentivized Lending also surfaced over time and will be discussed further down the page.
Diversity in DeFi 🎡
Here are a few of the many financial functions that can be performed using DeFi :
Lending & Borrowing : Conventional transactions like lending or Borrowing Money are already hosted by various platforms like Aave, Compound & Synthetix that offer incentives to users in form of native tokens or Cryptocurrencies to encourage participation.
Decentralized Exchanges (DEX) : These Platforms allow peer-to-peer transfer & exchange of tokens and provide users more freedom. There is no fee or cut charged by the platform for gains. Examples include Uniswap, PancakeSwap, etc.
Stable Coins : These are Blockchain based tokens that are pegged to Fiat currencies or other stable assets to prevent volatility. This is a widely used feature and various platforms like MakerDAO exist in this space.
Yield Harvesting : Perhaps the most beneficial of DeFi Functionalities, this process allows Investors to Lend or Provide Capital in form of Cryptocurrencies and gain high APYs(Annual percentage yield) by earning rewards or incentive tokens from the Platforms they interact with. This is popular with Protocols like Curve, Balancer, etc.
Flash Loans : This allows users to borrow and return funds in a single Block Transaction. Borrowers get a chance to earn gains by agreeing to a contract with the Blockchain if such a transaction is executed. It is a more recent functionalities added to the DeFi Ecosystem to attract more users.
What is DeFi 2.0🪃?
The DeFi Ecosystem boomed in 2020. Various successful Projects emerged & created value. Like any other Blockchain Application, initial versions of DeFi had their fair share of problems :
High Gas Fees and delays on the Blockchain. Simple transactions consume time. ⏲️
Limited User-base restricted to Web3 afficianados. Common users still remain alien to DeFi Platforms & continue to rely on Banks. 🏦
Many projects didn’t implement the DAO(Decentralized Autonomous Organization) Principles. 💳
DeFi 2.0 is an attempt to compensate for all of the aforementioned short-comings and introduce Innovative Solutions to build scalable & sustainable DeFi Platforms. They aim at building Layer-2 solutions to make the on-chain transactions more efficient. Some of the particular functionalities that DeFi 2.0 focuses on includes Liquidity Pools, Yield Farming, Smart Contract Insurances, Staking, etc.
What is happening right now🧩?
At the time of writing, August of 2022, the DeFi Ecosystem seems to be at a low but stable phase after all time high in 2020-21 (DeFi Summer). A lot of Platforms & Protocols are coming up with unique ideas. Staking & Yield harvesting is becoming more popular amongst participants. All previous problems faced with Liquidity Pools have been solved to a certain extent but a lot needs to be done. Upcoming protocols continue to attract massive investments from VCs & via ICOs.
There continue to be security threats for all platforms, especially after the collapse of the Terra Ecosystem which was a clear indication of the problems with ‘Algorithmic’ stable coins. Various protocols experienced Data breaches and Hacks, compromising system integrity. Several Scam & Phishing activities were reported across Protocols.
The combined TLV (Total Locked Value) of all DeFi Protocols remains to be high. The Top-5 Platforms are : MakerDAO, Aave, Curve, Uniswap & Lido.
Upcoming platforms are focusing on Layer-2 solutions like Polygon, StarkNet & ZkSync or Alternate Blockchains like Solana & Cardano. The much anticipated ‘Merge’ in the Ethereum Blockchain brings exciting opportunities to the DeFi space as the Layer-1 Ethereum Blockchain shifts from Proof-of-Work to Proof-of-Stake protocols.
Case Study : Hashstack Finance
Hashstack Finance is one of the very first under-collateralised Borrowing DeFi Platform. The initial condition that led to the inception of this Platform was the inefficiency in present-day DeFi platforms that still remains an issue to be tackled to motivate participants to switch from Centralized Financial Institutions.
Hashstack is a zK native protocol. It recently migrated to StarkNet, which is a permission-less decentralized ZK-Rollup operating as an L2 network over Ethereum. The Protocol has two instrumental features that separate it from other DeFi protocols, that is :
Open Protocol : This transparent approach acts as a middleware solution to the problem of overcollateralization in Lending.
EIP 5299 : This solves the storage & scalibility problems for Ethereum smart contracts and brings Web2 like agility to the functioning of the Protocol.
Hashstack, in its core essence provides the following benefits to the users :
Under - Collateralized Borrowing : When you borrow from a DeFi Protocol, you need to have Collateral. For example, if you intend to borrow $1000 worth of Dai-coins, you’ll have to put up $1000 or more worth of ETH as collateral. On the Hashstack protocol, your borrowed amount is almost 3 times your collateral value. This is better for borrowers & increases participation. In simple terms, you borrow more than you have to put up as collateral. You get upto 4.28x more loan on your Collateral than platforms like Aave.
Lending Benefits : If you choose to lend on the platform, you’ll earn upto 24% APY on your deposits in the same denomination. You’ll also earn monthly dividends on fixed deposits.
Hashstack has secured multi-million dollars in funding and is set to disrupt the DeFi space with its innovative solutions to improve efficiency and increase the DeFi user base as it spearheads the revolution towards a Sustainable & Open Financial Infrastructure for the world.
What Now❓
The DeFi ecosystem has certainly evolved since its inception. Several new & upcoming Protocols set to challenge the rigidity & opacity of Centralized financial Organization. DeFi, is certainly not mainstream as of today, a lot needs to be done. It is with consistency & innovation that DeFi continues to grow. It’ll certainly become an end-to-end alternative to our present conventional system and bring power & profits directly to every grass-root participant. Its principles of Transparency & Democratization will continue to inspire and encourage people to change and progress into a more open, free & independent Financial System.