The guide to DeFi ecosystem

Everything you need to know about the best Ethereum Defi Projects, that leverages decentralized networks to transform old financial products into trustless and transparent protocols.

The DeFi-ecosystem based on Ethereum is developing rapidly and attracts developers and venture financing. The largest share in the segment is held by exchanges and liquidity providers — about 22%. Asset management services account for about 19% of the market. According to The Block estimates, the DeFi ecosystem consists of at least 166 start-ups and protocols operating in 12 areas. Almost every day new projects appear in the DeFi segment. Some of them offer the market interesting solutions that attract investments and liquidity to the protocols. Other projects are nothing more than imitators seeking fleeting success on the hype wave. Some are created just to embezzle client funds and escape.

What is DeFi

DeFi is an ecosystem of decentralized blockchain applications that provide financial services without a centralized management organization. For example, a bank is responsible for the safety and security of its customers’ money and transfers between banks, organizations or people. In the DeFi ecosystem, protocols and smart contracts are responsible for the security of transactions.

Such applications consist of a set of products and services that replace banks, insurance companies, money and stock markets, and other services of financial institutions. Due to the compatibility of DeFi applications, users can combine different services using one mobile wallet. Key categories of DeFi: Stablecoins, Lending & Loans platforms, Exchanges (DEX), Crypto Asset Management, Lotteries & Betting, Derivatives, Insurance, and Payment Services.

Stablecoins

Stablecoins are important in this ecosystem because they are a reliable means of saving and allow you to create DeFi applications available to everyone. There are several common usage scenarios. For example, you can take a loan or be a lender and earn a monthly interest on it. The stablecoin market has made the crypto ecosystem more resilient and has added more currency volume for trading.

There are 2 types of stablcoins in the applications:

  • Centralized: USD Tether (UDST), True USD (TUSD), Paxos Standard (PAX), USD Coin (USDC), Binance USD (BUSD);
  • Decentralized: DAI, EOSDT, USDJ, MCR.

Tether (USDT) — one of the first centralized stablecoins, provided with 1:1 dollar ratio in the account of the company, which organizes the circulation of tokens USDT. Users of USDT are clients of such company’s services and trust it that tokens are fully backed by US dollars.

Decentralized tokens are designed to solve the problem of trust in the issuer of tokens provided with fiat reserves. Such tokens are put into circulation by means of overloaning cryptocurrency. For example, to get 100 DAI (1 DAI=$1), you need to make a reserve ETH with a collateral of 150% to the amount of emission, that is $150 in ETH.

Decentralized stablecoins operate in a distributed registry and are managed by decentralized autonomous organizations, and each member of the network can get public information about the reserve provisioning. Each DAO member may propose protocol improvements, just as anyone can vote to apply a change.

A DAO is a decentralized autonomous organization where members’ activities and resources are managed under predetermined rules with automatic control.

Decentralized lending

The issuance of loans on decentralized protocols allows any owner of digital assets to use them as collateral to obtain a loan. There are opportunities to generate income by adding their assets to the loan pools.

A lending pool is a form of association, in which the profit of participants is formed in accordance with their shares of participation.

The advantage of decentralized finance is that users do not need to register in the service to take a loan. Everyone who has a cryptocurrency wallet for decentralized applications can freely use the service.

It should be noted that decentralized lending works at the expense of over-provisioning the value of collateral assets. If the price of collateral grows, then the ability to take a loan becomes higher, when the price of collateral assets falls below a certain threshold, the assets are sold with the service fee. This is necessary to prevent the risk of default of lenders providing loans to stablecoin holders by providing liquidity pools. For example, a user takes a $10 loan from a DAI and provides it with a $15 pledge from ETH. If the ETH rate decreases, the loan security percentage will be lower than 150%, and if it increases, it will be higher than 150%. If the security percentage becomes lower than 150% — then the collateral in ETH is sold automatically. Therefore, it is recommended to leave the collateral above 150% of the loan amount.

Such loans are more often used by traders to earn on the difference in value of collateral ETH, additionally buying ETH on borrowed funds. But when the value of ETH collateral falls below 100%, the trader loses his collateral in full or in part. If the value of the collateral grows, it is possible to obtain an even bigger loan or to cover the current one from the profit from the ETH bought on borrowed funds. For example, to issue $1000 in DAI, ETH must be collateralized with more than $1500. On loans 1000 DAI we buy ETH, now we have ETH for $ 2500. Suppose that after a month ETH became 20% more expensive. Thus, earnings will be $2500+20%=$3000. Of this amount, $1080, including 8% service fee, goes to cover the loan. Net profit will be $420, against $300 without a loan. If the loan security ratio is always above 150%, this ensures that no penalty will be charged for the sale of the asset in the event of a sharp drop in its price.

Decentralized exchanges

DEX users trade assets between them directly from their wallets. Such exchanges play a key role in the development of decentralized commerce. They offer protocols and smart contracts on a blockchain for the transfer of ownership of digital assets.

Centralized Exchanges (CEXs) continue to lead the way in speed of execution of transactions as well as in the availability of asset volume at the requested price. CEX is more convenient for small transactions as it charges 0.2% of volume.

DEXs are just beginning to gain in popularity, according to the DeFi pulse, the total liquidity of popular DEXs has reached $1.5 billion. At the same time, DEXs have higher exchange fees and this also depends on the workload of the blockchain on which the DEX is built.

Using the example of Uniswap’s decentralized trading protocol, anyone can become a member of the ecosystem or a liquidity provider of trading pairs and earn up to 0.3% of their trading volume.

Forecast Markets

Forecasts, lotteries and bets refer to one component of DeFi applications. This part of the gaming market is optimized in order to eliminate the barrier of trust of “honesty” algorithms and payment for winning bets on any forecast. In other words, the software code of such applications is open and any user who knows a programming language can check the algorithms, on which the winnings are calculated. Data on the number of participants, their bets and forecasts are also publicly available. Funds of participants of such games at the time of betting are stored in the blockchain protocol. Depending on the outcome, positive or negative, the winnings will be credited to the winning party immediately or the funds are transferred to the other side of the dispute about the forecast.

Insurance

Insurance services are needed to compensate losses in case of an accident. The use of most DeFi platforms requires the blocking of funds in smart contracts. In order to protect your funds from possible hacking or error in your smart contract code, you can insure it. For this purpose, there are separate DeFi platforms that provide smart contract insurance services.

The Nexus Mutual platform offers any Ethereum blockchain smart contract insurance against hacking and potential code errors. The insurance coverage protects the buyer from financial losses.

For example, a trader blocks a MakerDAO 1000 ETH smart contract. He wants to insure this amount against possible errors in the smart contract code or hacking. To do this, on the Nexus Mutual platform, you need to specify the smart contract address, choose the insurance period, amount and currency of coverage. For example, to insure the MakerDAO smart contract for 1000 ETH for 1 year with the payment of coverage in ETH at the rate of ETH at the moment of insurance payment. The system will generate a price exactly for this insurance.

It is composed of the complexity criteria of the smart contract: the value of assets in the protocol, the number of transactions; as well as the senior period, the sum of insurance and the sum of assets supplied by risk assessors. The higher the sum of assets and the number of transactions in a smart protocol contract, the lower the cost of insurance. Risk assessors are users who bet their money on the fact that a smart contract is secure in exchange for interest on insurance. If the risk assessors have not put assets on the insurance application, the smart contract is not accepted for insurance.

Payment services

Despite the fact that today you can already make payments using BTC, ETH and other cryptocurrencies, payment solutions still require high attention to optimization and payment speed.

Each transaction when sending BTC is recorded immediately in the block, which is accepted in the blockchain within ~ 10 minutes. Payment services, such as Lighting Network, allow accepting and sending payments in bitcoins instantly.

In order to use such decentralized payment networks it is required to supply collateral in the asset, which is to be used within the payment network. For example, to use Lighting Network 1 BTC in a payment network, you need to create your own payment channel and block it through an installed 1 BTC smart contract. In addition, the owners of such nodes earn part of the commission from the whole network as much as their node occupies.

Decentralized payment networks are developing at a colossal rate. You can send bitcoins via Lighting Network via satellite communication immediately.

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Blockchain enthusiast developer and writer. I love video games, blockchain and the hot symbiosis of these two worlds.