Decentralized finance is a brand new development which is pumping new oxygen into the cryptocurrency industry. Currently, the crypto markets are recovering from the lows back in 2018 and are up more than 400% YTD. This high volatile nature of cryptocurrency is one of the reasons why traditional financial institutions rather stay away from it.
Despite these high risks cryptocurrency suffers nowadays, the technology and disruptive nature offer new opportunities to the markets. This is where decentralized finance(DeFi) kicks in. Crypto entrepreneurs love the idea of a decentralized architecture in the financial world. As a matter of fact, it’s revolutionary to put creation and regulation of digital money outside of companies’ and governments’ control.
Bitcoin and Ethereum networks
Bitcoin and Ethereum are the original DeFi applications. Both are controlled by large networks of computers, not central authorities. Many investors use bitcoin like gold, as a store-of-value investment that protects against inflation, while Ethereum has been instrumental—and controversial—in helping startups crowdfund their operations.
Although Bitcoin is a highly secure network with zero downtime, it isn’t scaled for daily use like the VISA network does. Currently, Bitcoin can handle about 7 transactions per second. The Visa network, which is the most used network nowadays, handles more than 24000 transactions per second. This is still a big difference!
Despite Bitcoin and Ethereum being slow wit handling transactions on bigger scale, the decentralized nature has a lot of support. As a result, new decentralized finance apps on the Blockchain are growing rapidly. In 2019, the total amount of money being held in decentralized payments networks has grown till more than 600 million USD.
The use case for decentralized payments
Although Bitcoin has a use case by sending value cross borders and in an instant way; why would there be a need for a decentralized payment network? The answer lies in its open nature. Let me explain this in further detail.
Currently, there are more than 1.8 billion people on this planet who don’t have access to an online bank account. The funny thing is that all these people do own a smart phone and are active online on a daily basis. This is where decentralized finance kicks in. As a result, decentralized finance offers a digital currency which is public, censorship resistant and on a global scale. Many crypto entrepreneurs see this as a very challenging opportunity!
|Good to know|
|Blockchain technology, digital finance, and programming are the key components in the rising decentralized world. Some interesting books:|
|Mastering Bitcoin: Programming the Open Blockchain|
|Mastering Ethereum: Building Smart Contracts and DApps|
So this brand new DeFi market sounds very promising. Are there currently any real-time developments concerning decentralized finance going on? The answer is yes. First, let’s start with the Ethereum platform, the second biggest Blockchain network on a global scale.
Decentralized Finance on Ethereum platform
Ethereum is the first Blockchain network in the world which introduced smart contracts. Smart contracts have the fundamental basics of setting up a decentralized finance platform. As a result, stablecoin Dai made birth on the Ethereum blockchain platform. This Dai token can be described as a Bitcoin-like digital token. Contra dictionary to Bitcoin, this cryptocurrency has very low volatility and is pegged to the U.S. Dollar. The idea behind this stable coin is to have a digital token that can be used on a daily bases.
MakerDAO is a decentralized credit platform on Ethereum that supports Dai, a Stablecoin whose value is pegged to USD. Anyone can use Maker to open a Collateralized Debt Position (CDP), lock ETH as collateral, and generate Dai as debt against that collateral. Dai debt incurs a stability fee (i.e., continuously accruing interest), which is paid (in MKR) upon repayment of borrowed Dai. That MKR is burned, along with the repaid Dai. Users can borrow Dai up to 66% of their collateral’s value (150% collateralization ratio). CDPs that fall below that rate are subject to a 13% penalty and liquidation (by anyone) to bring the CDP out of default. Liquidated collateral is sold on an open market at a 3% discount.
Other Ethereum DeFi projects
Compound is a crypto version of a money market fund, letting users earn interest. Also, it’s an open-source money market protocol on Ethereum for that lets users lend or borrow assets against collateral.
Anyone can supply assets to Compound’s liquidity pool and immediately begin earning continuously-compounding interest. Rates adjust automatically based on supply and demand.
Supplied asset balances are represented by ‘cTokens’: representations of the underlying asset that earn interest and serve as collateral. Users can borrow up to 50-75% of their ‘cTokens’ value, depending on the quality of the underlying asset.
Remove Funds and other rules
Users can add or remove funds at any time, but if their debt becomes under collateralized, anyone can liquidate; a 5% discount on liquidated assets serves as incentive for liquidators.
Compound holds 10% of interest paid as reserves; the rest goes to suppliers. As a matter of fact, the protocol charges no other fees and has no native token. Compound’s initial mainnet launch was in September 2018, and v2 rolled out in May 2019.
With support for BAT, Dai, ETH, REP, USDC, and ZRX. The upgraded protocol has been audited and formally verified.
Decentralized Finance on Ethereum: Dharma
Dharma is a peer-to-peer marketplace on Ethereum for non-custodial lending and borrowing of cryptocurrencies built on an extensible open source protocol. In Spring 2019, Dharma launched its revamped debt market, which matches borrowers’ requests with lenders’ offers for fixed-duration, fixed-rate loans denominated in and collateralized by ETH, Dai, or USDC.
Lenders can lock collateral for up to 90 days to earn interest at market-set rates. Borrowers can submit loan requests with custom amounts, durations, interest rate, liquidation threshold, and collateral amount and type.
Firstly, loan requests using Dharma’s default parameters may be matched instantly. Secondly, lenders start earning interest immediately upon depositing up to $5K in Dai or USDC in their Dharma account. Borrowers may repay early but will still owe the full amount of interest agreed to at origination. Liquidation occurs if a borrower fails to repay on time or if collateral value falls below the agreed-upon liquidation threshold.
Dharma has no native token. The Dharma protocol remains open-source and permission less for anyone to build third-party DApps on. Dharma’s smart contracts have undergone multiple independent audits.
Decentralized Finance on Bitcoin: The Lightning network
Last in this list, I want to mention the Lightning network. This second layer project has it’s fundaments on the Bitcoin blockchain network and could have big impact on decentralized finance.
The Lightning Network (LN) is a Layer 2 protocol on top of Bitcoin that seeks to improve scalability by moving small and frequent transactions off-chain, allowing for fast peer-to-peer transactions and low fees. As a result, LN is made up of a network of interconnected payment channels. Firstly, a channel is opened when two or more participants enter a transaction on the public Bitcoin blockchain and deposit some amount of funds. After that, while the channel is open, participants can sign any number of transactions among them (without exceeding the amount deposited).
The transactions are recorded and signed in an off-chain ledger instead of the main Bitcoin blockchain. When the channel is closed, the most recent state of the off-chain ledger is published to the main Bitcoin blockchain, updating each participant’s bitcoin balance.
Because LN nodes (i.e., users in LN channels) are interconnected, nodes do not always need to open a direct channel with everyone they want to transact with. Payments can be routed through other channels, provided that a path with adequate liquidity exists between the two transacting nodes.
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