Detailed explanation of how to DeFi for beginner, Welcome to follow and discuss with us
Author: Lunaray Team
0x01 Preview
Decentralized finance or DeFi is a financial service that allows users to use applications such as lending and trading without relying on centralized entities. These financial services are provided through decentralized applications (Dapps), most of which are deployed on the Ethereum platform.
DeFi is not a single product or company, but a range of financial services that mimic the traditional financial industry, including banking, insurance, bonds, money markets, and more. DeFi Dapps enable users to combine these services to achieve desired financial goals. Because of its composability, it is often referred to as monetary Lego.
For DeFi Dapps to function, collateral typically needs to be locked in smart contracts. The cumulative collateral locked in DeFi Dapps is often referred to as total value locked (TVL), and it is a growth indicator for the DeFi ecosystem. In our earlier release, we highlighted that TVL in early 2019 was around $275 million, and in February 2020 it reached a high of $1.2 billion.
Ethereum alone has a staggering $67 billion in TVL as of April 2021, which speaks volumes about how far we have come. This does not even include other blockchain networks like Binance, Solana and others. The combined total value locked across all blockchains amounts to $86 billion.
0x02 DeFi ecosystem
Because DeFi Dapps represent an innovation to traditional financial services by not relying on any middlemen. You should note, however, that the current state of DeFi is still highly nascent and experimental, with many projects improving rapidly every day. Over time, DeFi may develop maybe further and further.
0x02 How decentralized is DeFi?
Well,it not easy It’s not easy to answer that how decentralized DeFi is. For simplicity, we divide the degree of decentralization into three categories: centralized, partially decentralized, and fully decentralized.
1. centralized
- Features: Use centralized price feedback, centrally determined interest rates, centrally provided liquidity for margin calls.(eg:Salt、BlockFi、Nexo、Celsius)
- (eg:Salt、BlockFi、Nexo、Celsius)
2. Partially decentralized (having one or more of these characteristics, but not all)
- Decentralized price feedback, permissionless margin calls, permissionless margin liquidity, decentralized interest rate determination, decentralized platform development/updates
- （eg:Compound、MakerDAO、dYdX、bZx)
3.completely decentralized
- Features: Each component is decentralized.
- So far there is no DeFi protocol is fully decentralized yet.
0x03 Key categories of DeFi
- Stablecoins
- The prices of cryptocurrencies are known to be highly volatile. It is not uncommon for cryptocurrencies to see intraday volatility of more than 10%. To mitigate this volatility, stablecoins pegged to other stable assets such as the U.S. dollar have emerged.
- Tether (USDT) was one of the first centralized stablecoins to be launched. Each USDT is said to be backed by $1 in the issuer’s bank account. A major disadvantage of USDT, however, is that users need to trust that USD reserves are fully collateralized and do exist.
- Decentralized stablecoins aim to solve this trust problem. They are created by over-collateralization, run entirely on a decentralized ledger, and are governed by a decentralized autonomous organization. Anyone can publicly audit their reserves.Although stablecoins themselves are not financial applications, their role as a stable store of value in DeFi is crucial for everyone.
2.Lending and Borrowing
- The traditional financial system requires users to have a bank account to use its services, and there are currently 1.7 billion people who do not. There are other restrictions on borrowing from a bank, such as having a good credit score and having enough collateral to convince the bank that a person is creditworthy and capable of repaying the loan.Decentralized lending and borrowing removes this barrier, allowing anyone to stake their digital assets and get a loan with it. People can also earn yield on their assets and participate in the lending market by staking against lending pools and earning interest on these assets. With decentralized lending, there is no need for a bank account and no credit checks.
3. Exchange
- To exchange one cryptocurrency for another, exchanges such as Coinbase or Binance can be used. Exchanges like these are centralized exchanges, which means they are both intermediaries and custodians for trading assets. Users of these exchanges do not have full control over their assets, and their assets are at risk if the exchange is hacked and cannot pay their debts.Decentralized exchanges aim to solve this problem, allowing users to exchange cryptocurrencies without giving up custody of their cryptocurrencies. By not storing any funds on a centralized exchange, users do not need to trust the exchange to remain solvent.
4.Derivatives
- A derivative is a contract whose value is derived from another underlying asset, such as a stock, commodity, currency, index, bond, or interest rate.
Traders can use derivatives to hedge their positions and reduce their risk on any given trade. For example, imagine you are a glove maker and want to hedge against an unexpected rise in rubber prices. You can buy a futures contract from your supplier to deliver a specific quantity of rubber at a price agreed today on a specific delivery date in the future.A derivative is a contract whose value is derived from another underlying asset, such as a stock, commodity, currency, index, bond or interest rate. Traders can use derivatives to hedge their positions and reduce their risk on any given trade. For example, imagine you are a glove maker and want to hedge against an unexpected rise in rubber prices. You can buy a futures contract from your supplier to deliver a specific quantity of rubber at a price agreed today on a specific delivery date in the future.
5. Fund Management
- Fund management is the process of overseeing your assets and managing their cash flow to generate investment returns. There are two main types of fund management — active and passive fund management. Active fund management has a management team making investment decisions to beat a particular benchmark, such as the S&P 500. Passive fund management has no management team, but is designed in such a way as to mimic the performance of a particular benchmark as closely as possible.
In DeFi, some projects have started to allow passive funds to be managed in a decentralized manner. The transparency of DeFi makes it easy for users to track how their funds are being managed and understand the costs they will pay.
6.lottery
- Pooled funds are invested in a DeFi lending Dapp, and the interest earned is given to a random winner over a set time interval. Once the winner is selected, the person who bought the ticket gets their ticket refunded, ensuring that all participants have nothing to lose.
7. Payment
- A key role of cryptocurrencies is to allow decentralized and trustless transfer of value between two parties. As DeFi develops, more creative payment methods are being innovated and experimented with.The rate at which DeFi is born and innovation will undoubtedly introduce new ways of thinking for payments to address the many flaws of the current financial system
8. Insurance
- All tokens locked in smart contracts have the potential to be affected by smart contract vulnerabilities as there could be a large number of potential payouts. While most projects audit their codebases, we never know if smart contracts are truly secure, and there is always a chance that they will be hacked, resulting in losses. These risks highlight the need for insurance, especially when people are dealing with large amounts of money on DeFi. We will explore several decentralized insurance schemes in this book.
9. Governance
- Governance is essentially the business management philosophy of cryptocurrencies. In order for a DeFi protocol to govern a project, governance tokens are usually introduced, giving users the right to vote and have a say in the protocol’s roadmap. Of course, multiple toolkits and Dapps have also been developed to facilitate effective governance and complement existing systems.
