DeFi, Decentralized Finance, was born in 2018, and in a very short time it has experienced an incredible boom.
Defi is for all intents and purposes a new financial system that, like the classic system, does not depend on intermediaries and intermediaries such as banks: instead, it uses smart contracts on the blockchain. But what is a smart contract? This is software that performs operations independently when predetermined conditions occur. A program that regulates relationships and transactions between two or more parties. In the classical world, it could be a notary who validates a particular transaction. In the blockchain, the smart contract takes its place, freeing up millions of transactions in real time without anyone having to ask anyone else’s permission or approval: all in the terms outlined in the smart contract that, in fact, made possible the birth of the wonderful DeFi development .
Thus, decentralized finance runs entirely on the blockchain where, as a whole, it re-proposes the main models of classical finance in a decentralized key: loans, options, futures, insurance, buying and selling digital assets, and so on.
With DeFi, finally, cryptocurrency owners have the opportunity to try to earn more during the acquisition phase, and not just get an economic return at the time of the sale, if it is executed at a higher price than the purchase of course.
In just a few years, DeFi has literally exploded, spawning numerous solutions for making cryptocurrencies “work”, each capable of producing usually interesting, sometimes amazing, if not amazing payouts. As always with booms in a new market segment, along with solutions that are technically safe and conceptually sustainable, many speculative solutions have arisen, like snow in the sun with the arrival of the so-called crypto winter that few expected but did happen. Already an advantage, in fact, in achieving a remarkable clean-up and a major market rejuvenation.
During the recent Italian Tech Week, Decrypto held a masterclass (you can see it here) to tell, among other things, what the best DeFi solutions are today to make cryptocurrencies work. In my view, there are basically three: betting, borrowing and lending, and providing liquidity for DEX banks. Let’s see them more specifically.
Staking is the activity that consists of staking a certain number of digital assets on a blockchain validation node in exchange for a reward for each validated block. You are a user who believes in my project to the point of blocking a certain number of cryptocurrencies in my blockchain, and I reward you on the blockchain by giving you some of my other cryptocurrencies each time you are chosen to validate a block. It’s the so-called proof of stake, zero-energy model that Ethereum has recently switched to. There have long been blockchains, such as Polkadot and Solana, that allow anyone who owns their tokens to participate in it. At the moment, the tokens locked into Ethereum are not yet free, but it is reasonable to think that in a few months, starting with the famous “merger” that we also talked about in this blog, staking will be free for anyone.
Borrowing and lending pools are liquidity pools where cryptocurrencies can be loaned and borrowed. It can be borrowed for a few minutes or for days and months, as needed, and a fee is paid to the lender. Of course, no one knows who they borrow or to whom they lend. The amount of compensation is determined by the .. invisible hand of the market, which tends to increase the value of compensation itself when a cryptocurrency everyone wants is loaned and decrease it when demand drops.
In the liquidity pools of the so-called classic DeFi, in order to be able to borrow, say, 100 Ethereum, a higher value in high cryotos or stablecoins must be left as collateral. Recently, various types of pools have come on the market, mainly oriented towards the institutional audience and therefore theoretically more reliable, the model with low or even no guarantees has taken root. Of course, this presents significant risk areas for lenders, at least in theory.
In order to always attract new lenders, many liquidity pools have increased their fees by giving them certain amounts of their tokens, which is actually real marketing campaigns that were greatly appreciated as long as the value of these tokens increased. When these congregations collapsed with the onset of the crypto winter, they saw their operations collapse and with it the allure of compensation.
In general, today’s borrowing and lending groups require a high level of understanding on the part of the users in order to use them profitably. You need to know how to differentiate between different interesting and less interesting solutions and know how to identify potential risks.
Providing liquidity to decentralized exchanges is the third major opportunity to run your cryptocurrency. We’ll talk about that more extensively in the next post.