Decentralised finance has great significance in the cryptocurrency industry. The goal of DeFi is to change the financial system to be completely independent of the traditional (TradFi) economy. Different government and private organisations are investing in this goal, with thousands of developers jumping in to join the bandwagon.
How Ethereum and the DeFi Ecosystem Started
Vitalik Buterin was one of the creators of Ethereum after he worked on Bitcoin in 2013. Ethereum is a blockchain different from Bitcoin as it operates with different purposes:
for global payments, for digital money, and for blockchain applications. The DeFi ecosystem, one of the digital economies, works on Ethereum.
DeFi has an open-access code that anyone can open. It works with cryptocurrencies like ether. DeFi is not regulated by any central unit such as the government or a bank.
Decentralised finance continues to thrive because of the existence of smart contracts, cryptography, and blockchain technology.
Ethereum uses Solidity that allows all the algorithms required by financial contracts. Ethereum is not the sole crypto that runs DeFi applications. Some of these include Terra, Fantom, and Avalanche. DeFi was created first by Ethereum, which also happens to be the largest network.
How DeFi system works on lending and borrowing
Numerous platforms that operate on the DeFi ecosystem cater to lending and borrowing. It works when crypto positions are locked into a smart contract by clients, which they can borrow against their position. Another method is that crypto positions can be locked into a smart contract, and other users can generate yield by permitting their coins to be borrowed by other borrowers. The changes in DeFi affect the crypto market a lot. Bitcoin Prime discusses the nuances of DeFi and others in the crypto market.
It is crucial to note that the generated yields by lenders in the DeFi ecosystem are greater than the traditional financial system. It is more cost-effective to run a smart contract compared to running a traditional bank. Thus, the lender obtains all the generated yield from the lending money through the smart contract. Income can be generated through smart contracts.
The financial market has numerous rates that are super low with technological solutions provided by these affordable smart contracts. Central bankers are at the receiving end of the ire of many people because they allow these super-low interest rates. Savers and borrowers obtain an opportunity because of the provided solution brought about by DeFi technology. Thus, portfolio owners could make a smart move by focusing on their DeFi portfolios. There are many reliable websites that share the current trends in DeFi. One of these is Bitcoin motion.
Decentralised exchanges (DEX) became an offshoot of decentralised finance because of the creation of smart contracts, platforms that promote borrowing, and stable coins. In 2021, there was over $1 trillion in trading volume in DEX.
DeFi developed Compound, which belongs to the category of lending and borrowing application.
Crypto assets are supplied by users through this algorithmic protocol and start generating revenues. COMP is its native cryptocurrency. DeFi Pulse reports that locked Compound contracts are worth $8.9 billion. Users borrow stablecoins for spending or against crypto positions such as ETH. Traditional finance works on the principle of borrowing against appreciated security which is followed by Compound.
Supply and demand dictate the automatic interest rate adjustment with Compound compared to traditional banks. When tokens are supplied by the user to the Compound protocol, cTokens are credited to them. These underlying assets (cTokens) generate interest and serve as collateral. This is similar to traditional financial systems where immediate withdrawal and liquidity are offered to users.
Aave and flash loans
Aave is another platform of DeFi that caters to lending and borrowing, which runs on Ethereum. AAVE is its native cryptocurrency. As of the moment. Aave smart contracts have locked an estimated $11.8 billion. Crypto assets can be lent or borrowed through AAve. Yield can be generated by lenders with the protocol depending on the market’s supply and demand.
Flash loans are offered by AAVE. These allow the loan repayment and borrowing in the same block. The smart contract permits the transaction to go through if it happens within the same block. This technological innovation also works in arbitrage and quick trading. Aave loans are new in the financial market and do not exist in traditional finance.
DeFi aims to transform the financial market into one that is permissionless and trustless. DeFi has numerous advancements that must be understood by investors as well as financial advisors. DeFi technology is built on and enhances the current TradFi system in order to build a better one.