DeFi

What can Decentralized Finance (DeFi) be used for?

You probably already know, but one of the great advantages of Bitcoin is that no central party is needed to coordinate the operation of the network. But what if we use this as our core idea and make programmable applications on top of it? This is the potential of DeFi applications. No central coordinators or intermediaries, and no single points of failure. 

As mentioned above, one of the great advantages of DeFi is open access. There are billions of people around the world who don’t have good access to any type of financial services. Can you imagine how you’d manage your day-to-day without any certainty of your finances? There are billions of people who live like this, and ultimately, this is the demographic that DeFi is trying to serve.

Will Decentralized Finance (DeFi) ever reach the mainstream?

This all sounds great, so why hasn’t DeFi taken over the world yet? Well, currently, most DeFi applications are hard to use, clunky, break frequently, and highly experimental. As it turns out, engineering even the frameworks for this ecosystem is extremely difficult, especially in a distributed development environment.

Solving all the challenges of building the DeFi ecosystem is a long road ahead for software engineers, game theorists, mechanism designers, and many more. As such, whether DeFi applications ever make it to mainstream adoption remains to be seen.

What Decentralized Finance (DeFi) applications are there?

One of the most popular use cases for Decentralized Finance (DeFi) is stablecoins. Essentially, these are tokens on a blockchain with their value pegged to a real-world asset, such as a fiat currency. For example, BUSD is pegged to the value of the USD. What makes these tokens convenient to use is that since they exist on a blockchain, they are very easy to store and transfer.

Another popular type of application is lending. There are many peer-to-peer (P2P) services that allow you to lend your funds to others and collect interest payments in return. In fact, one of the easiest ways to do it is through Binance Lending. All you have to do is transfer your funds to your lending wallet, and you can start earning interest the next day!

Arguably the most exciting part of DeFi, however, are the applications that are difficult to categorize. These can include all kinds of peer-to-peer, decentralized marketplaces, where users can exchange unique crypto-collectibles and other digital items. They can also enable the creation of synthetic assets, where anyone can create a market for pretty much anything that has value. Other uses can include prediction markets, derivatives, and many more.

Decentralized Exchanges (DEXs) on Ethereum

A Decentralized Exchange (DEX) is a venue that allows trades to occur directly between user wallets. When you trade on Binance, a centralized exchange, you send your funds to Binance, and trade through its internal systems.

Decentralized Exchanges are different. Through the magic of smart contracts, they allow you to trade directly from your crypto wallet, eliminating the possibility of exchange hacks and other risks.

A great example of a decentralized exchange is Binance DEX. Some other notable examples built on Ethereum are Uniswap, Kyber Network, and IDEX. Many will even let you trade from a hardware wallet for maximum security.

Above, we’ve illustrated the differences between centralized and decentralized exchanges. To the left, we can see that Binance stands in the middle of transactions between users. So, if Alice wants to trade Token A for Bob’s Token B, they must first deposit their assets onto the exchange. After the trade, Binance will reallocate their balances accordingly.

To the right, however, is a decentralized exchange. You’ll note that there isn’t a third party involved in the transaction. Instead, Alice’s token is directly swapped for Bob’s by using a smart contract. In this way, neither party needs to trust an intermediary, as the terms of their contract are automatically enforceable.

As of February 2020, DEXs tend to be the most-used applications on top of the Ethereum blockchain. However, the trading volume compared to centralized exchanges is still small. Nonetheless, if DEX developers and designers flesh out the user experience to be more welcoming, DEXs could rival centralized exchanges in the future.