April 25, 2022
Last updated: October 18, 2023
Table of Contents
When you hear the word “Finance”, the most obvious thing that comes to your mind might be “banks”! What if I told you that you wouldn’t need a centralized authority to control your money and assets? Decentralized Finance, or DeFi solutions for short, intends to revolutionize the future of finance. But how? DeFi smart contract development services work by replacing centralized entities that control the flow of money with pieces of code called smart contracts that act as a bank.
Decentralized Finance solutions is a low-cost, fast, efficient, trustworthy and completely transparent global financial system based on public blockchains which operate without any central authority and is highly accessible through the internet.
Currently, the entire traditional finance industry is centralized. When compared to Centralized Finance or CeFi, which is severely outdated and highly manipulated making it wrought having risks like corruption, fraud and lack of transparency; DeFi solutions aims to provide a fast, low cost, efficient, trustworthy and completely transparent global financial system which is highly accessible through the internet, without any third-party or intervention by any central administration.
Decentralized Finance substitutes smart contracts for centralized entities like banks for managing the flow of money and assets. A smart contract is a pre-programmed, immutable agreement written in code that triggers particular events when certain conditions are met. This ensures reliability, transparency and atomicity in the transactions executed by the users.
The blockchain serves as the cornerstone for this initiative by bringing the power of decentralization into financial activities and thus every blockchain development company strives to reinforce the digital market with DeFi solutions. Also, any changes in the blockchain applications will have to go through a consensus process that no one person, company, or government has control over, which protects the integrity of the network.
In short, a ledger being maintained on a public blockchain network is completely transparent. Additionally it does not require users in the platform to trust each other and thus smart contracts pave the way for secure seamless transactions. A smart contract is an immutable agreement written in code that is pre-arranged so that certain events are triggered after meeting a specific condition, like sending a certain amount to someone only after availing a service from them.
Using this as a foundation, one will be able to unlock the many possibilities that DeFi development service has to offer.
DeFi, the new type of financial system, can exceed legacy systems in terms of efficiency and security. DeFi applications helps in Asset Management, Compliance and KYT, DAOs, creation of tokenized derivatives, Developer and infrastructure tooling, DEXs, Gaming, Insurance, Lending and borrowing, Margin trading, Tokenization and much more.
Now, having seen the benefits of DeFi, let’s look into some basic stack that any DeFi solution constitutes.
The closest alternative to fiat currency in the crypto world is a DeFi stablecoin. Stablecoins are cryptocurrencies where their price is designed to be fairly aligned to fiat money, with other cryptocurrencies making the token price ‘stable’. An example would be the DAI stablecoin, which is a cryptocurrency that is pegged to US dollars where one DAI is approximately worth 1 USD. This DeFi coin development mechanism bridges the gap between fiat currency and cryptocurrency and offers minimal price fluctuations of the obtained asset. This is unlike the cryptocurrencies such as bitcoin whose price is constantly in flux.
Nevertheless, the advantages of having DeFi stablecoins are transparent records, being over collateralized, and having minimal custodial risk. In finance, a custodian is an entity that holds a user’s assets for safekeeping to reduce the risk of loss or theft. The nature of blockchain makes it such that superior security is insured without the need for a custodian. Over collateralization simply means that there are more actual US dollars backing DAI than there are DAI in circulation.
One of the most popular DeFi development services is exchanges. Exchanges in DeFi development services are commonly referred to as a “DEX“‘ which is the short form for Decentralized Exchange.
DEX’s are financial applications that allow users to swap cryptocurrencies with other types of cryptocurrencies directly and peer-to-peer without an intermediary. Currently with centralized exchanges, intermediaries, like companies, function as middlemen to facilitate trading assets and charge their users trading fees while also being under-collateralized. This causes liquidity issues when trying to place large orders. With DeFi exchange development platforms like Uniswap, users can trade cryptocurrencies like Ether in exchange for DAI, with minimal custodial risk and maintaining complete control over their funds, instead of less secure and costly third parties.
Traditional exchanges use order books, whereas DEXs are collections of smart contracts. They employ “liquidity pools” in which investors lock assets in exchange for interest-like returns to ease trades and set the prices of multiple cryptocurrencies. This is against each other algorithmically using a protocol called Automatic Market Making or AMM.
You can also pool your tokens as pairs to existing pools or create new pools and contribute to these exchanges. By doing so, you earn interest as a “liquidity provider” from the transaction fee paid by the swappers who come to the platform. If you change your mind, you could always get back your tokens from the pool by burning your LP (liquidity provider) tokens that you minted while contributing to the pool.
Calibraint as a Blockchain and DeFi Development Company offers out-of-the-box decentralized finance development services to help clients construct decentralized finance applications that deliver transparency, trust, and security to their financial processes.
Crypto-financing allows crypto investors to borrow loans by offering cryptocurrencies owned by them as collateral or lend the crypto assets and earn interest for that period. Lending cryptocurrency in exchange for interest is a great way to earn passive income for HODL’ers who have idle assets that they’ve been holding for an extended period. Unlike traditional peer-to-peer lending available with centralized services like Lending Club, DeFi money market projects like Compound allows its users to lend their cryptocurrency assets to a pool with other lender funds, instead of lending it directly to a user and earning interest by doing so.
Nevertheless, borrowers can secure a loan by depositing a certain amount of some cryptocurrency as collateral. If the value of the underlying collateral for the loan ever drops below the amount they borrowed, the loan instantly goes into liquidation eliminating the position. In this scenario, a borrower would pay a penalty to the liquidators and any excess collateral would be issued back to the lenders.
The advantage of DeFi money markets is that it is completely transparent. So anyone at any time can review the number of loans issued from a lending pool to ensure that the liquidity pool is over collateralized or that there is more than enough cryptocurrency backing the outstanding loans.
Apart from the above, we also have Synthetic tokens that mimic the value of another underlying asset. For example, using the synthetics platform like Linear, users can use Ether as collateral and mint Synthetic DAI. With Synthetic DAI a user gets simulated price exposure to the US dollar. Synthetics are used to simulate activities like funding, liquidity creation, and market access while offering complete transparency and superior security to the underlying cryptocurrency assets.
Synthetic assets can create possibilities in interesting scenarios. Consider a synthetic asset token that keeps track of a company’s CO2 emissions in a manufacturing zone. As companies issue CO2 tokens, token holders (who may be locals living nearby, city authorities, or outside speculators) profit as emissions grow. Companies, on the other hand, earn from lower emissions by keeping tokens incentivizing them to continue reducing CO2 emissions.
To gain a comprehensive understanding of decentralized finance, it is of utmost importance to examine the key benefits of DeFi. These benefits of DeFi highlight the value proposition and encompass the key DeFi features that can be incorporated into DeFi solutions. Below are several noteworthy characteristics that are commonly associated with DeFi.
Interoperability: Interoperability stands as a significant benefit of DeFi, as it enables the seamless connection of various applications. Through this connectivity, DeFi applications can collaborate to develop advanced financial services and products. This has the potential to foster a new financial ecosystem that is characterized by enhanced efficiency, openness, and accessibility.
Permissionless: A prominent DeFi advantage that captivates the interest is its permissionless nature. Unlike traditional finance, DeFi applications do not adhere to conventional access principles. Instead, they embrace an open and permissionless access model where anyone with an internet connection and a crypto wallet can access DeFi solutions. Geographical location and fund amount become irrelevant barriers, as DeFi welcomes everyone virtually into the financial system.
Community-driven: At the heart of DeFi benefits lies a community-driven approach, where developers and users unite to foster the movement. By cultivating a sense of ownership and responsibility, users are motivated to actively participate in the system and contribute to its continuous growth and development. This collaborative spirit empowers individuals to engage with and shape the future of DeFi, creating a dynamic ecosystem fueled by collective efforts.
Decentralized Governance: Decentralized governance plays a pivotal role in many DeFi applications, as it empowers token holders to partake in decision-making processes instead of relying on a central authority. This democratic approach ensures that the system is governed by the collective wisdom and input of the community, rather than being controlled by a limited group of individuals or institutions. By embracing decentralized governance, DeFi fosters transparency, inclusivity, and community-driven control, enabling the collective to shape the direction and policies of the system.
Security: Security remains a top priority in the DeFi market, despite the occurrence of numerous notable hacks and security issues. The sector consistently strives to improve its security protocols to ensure the safety and protection of funds. Many DeFi applications employ advanced measures such as smart contract auditing and state-of-the-art encryption to provide robust security for their users’ assets.
Immutability: Immutability is a crucial aspect of DeFi’s popularity, as it aligns with the goal of financial inclusion for all individuals. By leveraging immutability, DeFi can significantly enhance security measures and provide a wider scope for audits. The ability to prevent unauthorized modifications and guarantee safe and secure data transmission establishes blockchain’s credibility as a valuable addition to the financial world. With this assurance of integrity, DeFi holds the potential to deliver secure and trustworthy transactions for all participants.
Yield Generation: DeFi benefits offer opportunities for users to generate passive income through various mechanisms like liquidity provision, staking, yield farming, and lending/borrowing activities. These yield-generation opportunities attract users to participate in the DeFi ecosystem.
Programmability: DeFi leverages programmable smart contracts, enabling the automation of financial processes and the creation of complex financial instruments. This programmability allows for the development of innovative and customizable financial solutions.
While there are numerous advantages of DeFi, it is not exempt from certain challenges and potential pitfalls. The primary difficulties faced by Decentralized Finance include:
High Gas Costs: The usage of the Ethereum blockchain entails significant gas fees, which have become a major concern for Decentralized Finance. Users are thus required to pay these fees for transaction processing. As the popularity of Decentralized Finance applications grows, gas prices rise, making the system less accessible for users.
Regulatory Ambiguity: Decentralized Finance operates outside the realm of conventional financial systems, leading to uncertainties regarding its regulatory framework. The lack of clear regulations can deter traditional financial institutions and institutional investors from participating in Decentralized Finance, limiting its potential impact.
It is important to address these challenges to ensure the sustainable growth and adoption of Decentralized Finance and ongoing efforts are being made to mitigate these pitfalls and develop solutions that enhance accessibility, scalability, and regulatory clarity in the Decentralized Finance ecosystem.
It’s a matter of fact that DeFi solutions have been transforming the financial sector. With all these endless possibilities of using DeFi development services, there also comes a risk of losing your assets due to some scenarios. Well, insurance platforms like Nexus Mutual and Bridge Mutual have got you covered!
Decentralized insurance protects users against the risks associated with using these financial protocols. In decentralized insurance, you can choose to provide insurance in exchange for interest or buy insurance by paying some amount as a premium, to get covered in case you lose your capital due to a specific predetermined event.
While these DeFi solutions and Decentralized Finance applications are attracting an increasing number of users, it’s difficult to predict where they’ll go. Many believe that the DeFi development service projects have the potential to become the next big thing and decentralize the traditional financial system.
Despite the challenges that come with working on the cutting edge of innovation, the world of decentralized finance is on the road to prosperity. Cryptocurrency has become the most recent digital offering and in the coming years, every single financial service under the fiat scheme will be rebuilt in the Decentralized Finance and open finance environment. Well, without a doubt crypto wallets will become the hub for all digital asset activity in the near future making the DeFi development services more efficient.
DeFi refers to a system of financial applications and services built on blockchain technology, aiming to provide open and accessible financial solutions without the need for intermediaries or traditional financial institutions.
The benefits of DeFi include:
Compound, Aave (AAVE), Synthetix (SNX), Uniswap (UNI) etc are all examples of DeFi.
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