- Application areas for DeFi and Ethereum DApps applications
- Risks associated with DeFi
The decentralised finance / DeFi ecosystem is still relatively young, and currently most DeFi DApps are mainly available on the Ethereum blockchain.
Therefore, for their application, the DeFi DApps listed below are based on Ethereum DApps and aim to provide a deeper fundamental introduction to DeFi in cryptocurrencies.
Store of Value
After Bitcoin (BTC), Ether (ETH) is the second largest cryptocurrency in terms of market capitalisation. Both cryptocurrencies have seen impressive increases in value since their inception. In times of zero or negative interest rates and high inflation, many investors are looking for alternative solutions to store value. These often include precious metals such as gold or silver. Since the advent of Bitcoin, cryptocurrencies have also been recognised as a suitable means of storing value, although they carry a much higher risk.
However, the benefits of the value storage function can only be expected in the very long term. In the short to medium term, all cryptocurrencies, as well as ETH, are subject to extreme price fluctuations. These fluctuations affect the credibility of cryptocurrencies and thus their use. So-called stablecoins are designed to avoid this troublesome volatility.
Stable coins are linked to other stablecoins, usually the US dollar. There are currently more than 15 different stablecoins. The five largest in terms of market capitalisation are the USDT, USDC, PAX and DAI. The best known and oldest stable coin is the tether (USDT). 1 USDT should always correspond exactly to 1 US dollar, and all USDTs are ‘officially’ backed by the same number of US dollars in a bank account.
In short, USDT is a central stablecoin backed by a fiat currency – the US dollar. DAI, on the other hand, is a decentralised stablecoin based on the Ethereum Blockchain (ERC-20 token) and pegged to the US dollar via smart contracts. DAI can be purchased on trading platforms or in the form of credits. A minimum amount of ETH or BAT must be deposited as collateral for this ‘coin’. If the borrowed DAI is then exchanged for ETH and the exchange rate between ETH and USD rises, there will even be a profit.
The platform on which DAI can be minted is MakerDAO, one of Ethereum’s most widely used DeFi platforms. DAI is therefore a decentralised stablecoin backed by cryptocurrencies such as ETH and BAT. DAI is currently the most widely used stablecoin for the DApps Decentralised Finance (DeFi) application on Ethereum. Even though stablecoins such as DAI are not necessarily DeFi applications per se, they facilitate access to all other DeFi (Decentralised Finance) DApps by representing a stable store of value.
If you want to securely store ETH, stablecoin DAI or other ERC-20 tokens, you need a wallet. Wallets are one of the first consumer applications for cryptocurrencies. They provide a very simple way to access cryptocurrency on the blockchain. Without a proper wallet, DeFi applications cannot be used on Ethereum. A wallet is nothing more than a user-friendly interface to the blockchain that manages private keys. In order to store funds securely, it is always recommended to use a wallet whose private keys you control yourself, such as Trezor or Ledger.
For those who prefer to store private keys on their own, Metamask’s desktop wallet, which can store ETH and all ERC-20 tokens, is recommended. In addition, almost all decentralised financial DApps from Ethereum can be easily and intuitively used with Metamask.
Smart payments with DeFi
ETH and DAI, but also all other cryptocurrencies, can be used directly for decentralised payments. These payments are now possible at very short notice and anywhere in the world, with very low fees. Nevertheless, there is potential to further improve decentralised payment transactions. In particular, the speed of payments due to insufficient transaction scalability is not yet suitable for mass consumption.
One of the best-known projects aimed at improving the scalability of bitcoin payments is the Lightning Network. However, there is another interesting approach that could revolutionise payments as we know them so far: automatic, continuous payment during or just after a service is provided. As a rule, salaries are only transferred at the end of the month, but transferring salaries to a bank account every day would be too much effort and cost.
This is where DeFi’s decentralised finance comes in, offering completely new possibilities. So-called payment streaming is made possible by means of smart contracts. Payments are made in much shorter intervals without increasing effort. In concrete terms, this means that, for example, a one-hour consultancy service can be paid for in a minute rather than in several weeks. In this way, the quality of life for hourly and daily workers can be sustainably improved. DApp Sablier makes such payments possible.
Other noteworthy DApps include Request Network,, xDAI or Connext Network.
DeFi: lending and borrowing
Lending is the best financial service provided by banks. Without credit, the economy usually cannot grow. However, lending standards are high. Not only do they require formal access to funds in the form of a bank account. Your credit history is also checked according to strict criteria depending on the size of the loan.
Do you have sufficient collateral? Can you convince the bank of your skills or business plan? If not, no points are awarded. Thanks to DeFi, it is now possible to borrow without banks and without a bank account, and to act as a lender yourself and thus earn interest income. Basically anyone in the world can borrow or lend capital in the form of cryptocurrencies. All you need is a properly filled wallet. Borrowers only need to properly secure the loan. There are no other approval criteria and the user remains anonymous. One of the most commonly used Ethereum platforms for lending and DeFi loans is Compound.
Lenders make their cryptocurrency assets available in this pool, while borrowers can borrow from the pool with adequate collateral. Smart blockchain contracts uniquely bridge the gap between lenders who want to receive interest on unused assets and borrowers who want to borrow funds for urgent investment purposes. Other noteworthy DApps include MakerDAO, Instadapp or Nuo Network. Staking Rewards or DeFi Rate offer a very good overview of different lending platforms in terms of interest income.
Zdecentralizowany handel kryptowalutami – DEX
Handel kryptowalutami odbywa się zazwyczaj na tzw. giełdach centralnych. Podobnie jak w przypadku banków, dostęp do nich uzyskuje się zazwyczaj dopiero po przeprowadzeniu kontroli KYC i AML. Ponadto giełda bierze na siebie odpowiedzialność za przechowywanie kryptowalut. Niestety, lista zhakowanych giełd jest bardzo długa. Zdecentralizowane giełdy (DEX) zostały zaprojektowane w celu rozwiązania właśnie tych dwóch problemów. Brak ograniczeń dostępu i pełna kontrola właścicielska. Kryptowaluty opuszczają portfel tylko w momencie wymiany.
Płynny mechanizm porównywania ofert kupujących i sprzedających zapewnia zwykle przejrzysty arkusz zleceń. Im więcej zleceń, tym większa płynność. Zazwyczaj jednak większe giełdy zapewniają wystarczającą płynność, aby umożliwić szybką wymianę. W niektórych DEX wykorzystywany jest również arkusz zleceń, przy czym jednym z największych wyzwań jest tutaj wystarczająca płynność. Skutkiem tego może być bardzo długi czas oczekiwania na realizację zlecenia. Problem ten rozwiązują DEX-y oparte na płynności, takie jak Uniswap.
W tym przypadku użytkownicy zapewniają indywidualny wolumen co najmniej jednej pary walutowej i otrzymują za to część opłat giełdowych. Porównywanie zleceń odbywa się przy użyciu “Algorytmu automatycznego animatora rynku”. Wraz ze wzrostem popytu na daną kryptowalutę algorytmicznie wzrasta również jej cena handlowa. Dzięki temu dostawcy płynności mogą w każdej chwili wycofać swoje kryptowaluty z puli, nie ponosząc przy tym straty w łącznej wartości udostępnionych par walutowych. Inne godne uwagi DEXy to Bancor, Kyber czy 0x. Obecnie istnieją również agregatory płynności, takie jak 1inch czy Totle, automatycznie przydzielające zlecenia do różnych DEX-ów, aby zapewnić najlepsze ceny.
If simple trading is not enough for you, DeFi also offers a ‘margin trading’ option. The dYdX platform offers credit trading and margin trading in one. If you want to enter a 5x ETH position and you don’t have enough ETH, you can simply borrow it from dYdX and keep some of it if you succeed in margin trading.
Asset management – flow of funds from DeFi
The task of fund managers when trading securities is to actively manage the fund to outperform a standard index, such as the DAX, to ensure maximum returns for clients. However, it turns out that major stock indices outperform actively managed funds over the long term. Since then, index funds (ETFs – exchange traded funds) have evolved considerably and the number of managers and analysts has declined. DeFi does not stop at this financial service either and makes the classic fund manager redundant.
In addition, fees are sometimes lower. Active management is being replaced by algorithms and smart contracts. Users take on the role of passive asset manager. The challenge is to choose an investment strategy that is suitable for oneself. A DApp called ‘Tokensets‘ shows exactly how this can happen. Here, users can acquire so-called Stragegy Enabled Tokens (SETs). Each SET is an ERC20 token on the Ethereum blockchain and consists of a basket of different cryptocurrencies, which are automatically and regularly replenished depending on the chosen investment strategy. There are two investment strategy choices: “Robo Sets” and “Social Trading Sets”. Trading algorithms such as “Buy and Hold” or “Trend Trading” are hidden behind the Robo-Sets. Social Trading Sets, on the other hand, allow you to copy the trading strategies of successful traders.
Handel instrumentami pochodnymi to najlepsza dyscyplina w inwestowaniu finansowym. Handel pochodnymi instrumentami finansowymi jest dość skomplikowany i bardzo ryzykowny. Tylko bardzo doświadczeni traderzy mogą się tu zadomowić. To wyrafinowanie utrzymuje się w DeFi. Instrument pochodny to produkt finansowy, którego wartość jest pochodną innego składnika aktywów bazowych, takich jak akcje, towary, waluty, indeksy, obligacje lub stopy procentowe. Handel instrumentami pochodnymi pozwala uczestniczyć w rozwoju innych aktywów bez posiadania ich na własność. Typowe rodzaje instrumentów pochodnych to certyfikaty, opcje lub kontrakty, które są wykorzystywane do celów spekulacyjnych lub zabezpieczających. Pozwalają one na spekulację kierunkiem ruchu instrumentu bazowego lub zabezpieczenie przed zmiennością instrumentu bazowego.
Największą platformą Ethereum dla instrumentów pochodnych DeFi jest Synthetix. Dostępne tam instrumenty pochodne nazywane są “syntezatorami”. Syntezatorami można handlować na giełdzie Synthetix-Exchange. Oprócz niektórych kryptowalut, za pośrednictwem syntezatorów handluje się obecnie złotem i srebrem, a także niektórymi walutami fiat jako instrumentami pochodnymi. Token sieciowy Synthetix (SNX) jest używany do tworzenia i ochrony różnych syntezatorów. Osoby uczestniczące w zakładach SNX są wynagradzane opłatami generowanymi z obrotu na giełdzie Synthetix-Exchange.
Lottery with DeFi
DeFi applies the idea of winning something by saving money to a gambling approach. A lottery in which there are no losers. This does not mean that all participants win. However, everyone who did not draw the winning ticket will get their money back. The DApp Pooltogether lottery makes this possible. An attractive prize awaits the winner, while all those who do not win will have their stakes refunded. Instead of funding the winnings from ticket revenue, the winnings are generated through interest income on Compound’s lending platform.
As with all other DeFi DApps, this works automatically through smart contracts on the blockchain. Ticket funds are transferred to the DAI or USDC as liquid funds. The interest earned then feeds into the profit. Non-winners get their shares back in the DAI or USDC. There is no time limit, any player can withdraw their bet at any time.
Non-winners only incur an opportunity cost, which corresponds to the lost interest income on the deposited capital. Another DApp worth noting is Uma.
Prediction market projects such as Augur or Veil are developed as derivative platforms.
DeFi / Decentralized Finance – Dashboard
What might the use of all these DApps look like in practice? Various experience reports show what profits are possible with DeFi. Anyone who can convince their employer that they can be paid directly in ETH via the Payment Streamer Sablier only needs to provide a Metamask wallet address.
Part of the ETH can then be left in the wallet for a long time to speculate on the increase in value. Another part can be exchanged for USDC on the Uniswap service. A few borrowed DAI can be included in a complex smart contract to earn interest. DeFi insurance at NexusMutual protects against total loss. Another part of the interest earned in DAI can be used to trade derivatives on Synthetix and to generate additional income from hedging trades on dYdX. In addition, lottery tickets can be purchased at Pooltogether. And, so as not to lose the overall picture, all applications can be tracked transparently via a dashboard such as Zapper.
Risks associated with DeFi
While the DeFi system offers many benefits, it certainly carries some risks.
- Technical risks – hacks or bugs in the smart contract code
- Admin key risk – the master private key for the ledger could be compromised
- Base layer risk – Blockchain capacity is critical to the development of a DeFi implementation
- Legal risk – states cannot prevent access to the blockchain, but can block access to the interface via IP addresses
So far, mainly technical risks have given DeFi a negative tone. However, it is still not possible to protect against all risks with insurance. The ability to control these risks will also determine whether DeFi can prevail. Currently, the majority of DeFi’s DApps are based on Ethereum, but this does not mean that this must remain the case in the future. In this case, the deciding factor will be whether Ethereum can be successfully converted into a consensus mechanism for proof-of-stake. Proof-of-Work does not offer sufficient scalability and would drive the network to the limit of its load if the use of DeFi DApps continues to grow significantly. Overloading the blockchain would be fatal, especially for time-critical smart contracts. The third and final part of ‘DeFi for beginners’ looks at alternatives such as bitcoin and other smart contract networks.
Author: Dean Dec
Dean is a passionate advocate for the financial freedom and independence offered by Bitcoin and the cryptocurrency space. Enthusiastic about the cutting-edge technology and the dynamic community behind it, Dean enjoys sharing valuable insights and empowering others to embrace the transformative potential of digital currencies.
- More Posts(4)