What are the main use cases of DeFi?
The DeFi movement has always been about developing a substitute financial system that’d rival, and eventually surpass, centralized monetary services in the global financial markets.
While it’s true that DeFi is still in its development stage and has a long way to go still before achieving its objective, there have already been several prominent use cases of DeFi so far – sectors where DeFi has proven to be a massive success. Below we have rounded up some of the best practical examples of decentralized finance seen till date.
1. Trading
Providing a new and secure way of trading was one of the primary aims behind a decentralized financial system’s initiation, and of course remains one of its basic functions. Across decentralized exchange platforms, liquidity pools and decentralized marketplaces, a range of trades happen within the DeFi space, from derivatives trading to token exchanges to margin trading to token swaps.
2. DEXes/ Decentralized Exchanges
The most broadly known application of DeFi so far has been the DEX, or decentralized exchanges. Decentralized exchanges are, of course, cryptocurrency exchange platforms that allow all users to perform P2P (peer-to-peer) transactions between themselves. Users can therefore control their own funds without a central administrative figure watching over.
The trading fees are much lower too. DEXes provide increased liquidity, safeguard all personal data of the users and their funds against threats of hacking and lower the risks of market manipulation by a considerable margin. Another key feature of DEXes is that they allow physical assets to be tokenized. Thus, the exchanges are swifter and safer compared to traditional trading methods.
Right now, some of the widely popular DEXs in the DeFi world include Yearn and others
3. DeFi derivatives
A derivative, as you’re probably aware, is a coded financial agreement that procures its value based on the performance of an underlying entity. This entity can be a crypto asset, fiat currency, a valuable commodity such as gold, or stocks, bonds etc. DeFi derivatives, similarly, can represent both real world and virtual assets.
For a DeFi derivative, smart contracts embody contracts which auto-execute in a permissionless manner. There are two basic benefits to trading a DeFi derivative –
Avoiding the risks associated with any upcoming price fluctuations of a particular asset by agreeing to trade at a fixed price in the future.
Potentially earning profits by speculating on a certain asset’s future performance.
Here are some of the prominent types of derivatives contracts:
Futures:
A crypto futures contract contains an agreement to buy/sell the underlying crypto asset at a specific point in time in the future.
Options
Crypto options allow the holders the right to buy or sell the underlying assets at a certain price, but they are not obligated to perform the trade.
Swaps:
Swaps are derivatives contracts through which counterparties exchange the cash flows or liabilities associated with one financial instrument for another. Swaps are customized based on the requirements of both sides involved.
Perpetual Swaps: Perpetual swaps are very similar to regular futures contracts, except that they don’t have expiry dates.
4. Tokenization
A token, in the case of DeFi, is a virtual asset minted, issued and managed on a blockchain. Digital tokens are securely coded so they can be transferred instantaneously and are programmed to carry a bunch of functionalities. Tokenization is a native feature of the Ethereum blockchain, meaning it can provide DeFi platforms on the same blockchain with a range of economic benefits. Digital tokens have come out as a secure way for users on DeFi platforms to store their asset values, and trade without ever risking the actual assets.
DeFi platforms usually offer tokens to provide users with an attractive deal to invest in a particular platform. Some protocols give away platform specific tokens that give the tokenholders governance powers. Others can incentivize users to try out a certain application. For instance, the Yearn.Finance platform offers the $YFI token, and Compound gives out the $COMP token.
5. Stablecoins
Stablecoins are essentially cryptocurrencies. The only difference is that the value of a stablecoin can be tethered to the value of another cryptocurrency, a physical currency like the US dollar, or even the price of a valuable physical asset, like gold. The primary goal of stablecoins is to reduce the risks associated with the price fluctuations of a regular cryptocurrency. They also offer price stability.
Currently, most stablecoins exist as tokens on the Ethereum blockchain. They are used for payments on DEXes, or for lending and borrowing purposes. Some popular stablecoins are USDT, USDC, and DAI.
6. Synthetic Assets
Synthetic assets are virtual assets that provide exposure to other real world assets such as fiat currencies or precious metals like gold, or cryptocurrencies. Basically, anything with a dependable price feed can be translated into a synthetic asset.
These assets can be staked as collateral on DeFi platforms and have synthetic assets (which are basically crypto tokens, much like stablecoins) minted against them. For example, Synthetix is a synthetic asset protocol.
A user can store Synthetix’s token SNX or ETH as collateral on Synthetix, and have synthetic assets minted against it.
7. Lending and Borrowing:
P2P (peer-to-peer) lending and borrowing platforms are one of the most extensively used applications of the decentralized finance system. DeFi lending platforms give out loans to individual borrowers or organizations in a trustless way. There’s no third party interference required, and they allow lenders to earn interest in the form of crypto coins on their deposited funds.
Here’s some of the advantages DeFi lending platforms offer over the traditional lending/borrowing procedure –
More easily accessible to both lenders and borrowers
Instant fund settlements through smart contracts
Total transparency in the fund flow
Reduced risks
Flexibility in lending and borrowing
The DEX platform Compound is a good example of a DeFi lending/borrowing protocol.
Compound is an algorithmic, autonomous interest rate protocol. By providing interest rate markets on Ethereum, it allows lenders to earn interest on the assets they have deposited in the Compound lending pool. The Compound smart contract is coded to match borrowers and lenders and calculate the interest rate for every specific situation.
8. Asset Management
Finding beneficial exchange platforms, strategizing and distributing assets for portfolio diversification, and keeping track of all investments and trades across multiple platforms can be fairly complicated. This is where DeFi asset management tools come in, which include virtual apps and wallets for securing and managing financial assets on behalf of the users.
Crypto wallets let you interact with DeFi platforms and handle all transfers of funds. This includes buying, selling, moving cryptocurrency from one system to another, and earning interest on deposited assets.
9. Insurance
As mentioned before, decentralized finance is still developing. Even though it was designed to be fully secure and risk-free, users have previously faced all sorts of vulnerabilities. These have included smart contract breaches due to bugs, theft of personal information/funds, and compromised private keys.
The decentralized nature of the system makes it really difficult to reverse any losses suffered; this is why DeFi insurance – one of the more recent innovations within the DeFi space – plays a key part in giving the users the maximum possible security, and serves to attract more investors and traders to DeFi.
Through DeFi insurance protocols, users can take out insurance policies on cryptocurrencies, smart contracts, or their funds to cover any claims in the future.
10. DAOs/ Decentralized Autonomous Organizations
A decentralized autonomous organization is an institution that operates as per encoded rules that are transparent. It is controlled by the members of the organization instead of a centralized authority. Some well-known platforms within the DeFi world have launched DAOs to provide their user-bases with decentralized governance powers, run financial operations and fundraise among other things; Compound Finance and MakerDAO being two of the foremost examples.
11. Payments
The peer-to-peer payment system is one of the basic features of decentralized finance, since it also happens to be a key quality of the blockchain tech. DeFi payment networks allow all users to trade directly with each other, with no intermediary intervention required.
DeFi payment solutions can create a convenient financial system for the large part of the global unbanked or underbank population. Plus, they can convert the current market structures to benefit all parties involved in the trades.
12. Decentralized Marketplaces
DeFi protocols have already been used to back online marketplaces so they can serve consumers worldwide. All functions become a lot easier – from payments to the exchange of products.
The open source structure allows rules governing the marketplace to be transparent and visible to everyone operating on the network. Plus, the combination of DeFi’s transparency and immutability make sure that features such as customer ratings and reviews are completely honest and indubitable.
The DeFi space, at its current stage, faces some issues. The foremost of them being the fact that the system structure isn’t yet ready for mundane use. It’s why it hasn’t been replacing the traditional financial systems in the mainstream markets yet. However, decentralized finance continues to grow and widens its horizons to introduce financial uses and opportunities never imagined before. It’s undeniable DeFi already holds the potential to revolutionize financial sectors on a global scale.
That’s it for this one folks. Hope this content will give you a better understanding of all the different use cases of DeFi.
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