With the advent of anonymity, the blockchain-based coins known as the cryptocurrencies or crypto coins have gained immense importance. The initial cryptocurrency was Bitcoin (BTC). However other crypto coins or digital assets like Monero (XMR) and Litecoin (LTE) followed the path. Currently, there are numerous options to choose from. The DeFi tokens are digital currencies but differ from the usual cryptocurrencies.
In This article, we will learn about DeFi and its tokens in detail. We will try to explain everything is a lucid language that is easily understandable by both the beginners and the intermediates.
What Is DeFi? How Does It Work?
DeFi is the abbreviated term for Decentralized Finance. DeFi can be termed as a digital financial system operating independently and is autonomous. Meaning, that it does not include the centralized financial intermediaries.
Now, what are centralized financial intermediaries? The centralized financial intermediaries are credit unions, banks or the insurance funds. The centralized platforms can be managed by a group of people or an individual usually within the jurisdiction of a Fintech company or financial technology.
Decentralized finance utilizes a set of smart contracts and algorithms for executing its functions. Smart contracts are automated agreements that do not require any centralized financial intermediaries such as banks or related institutions. They utilize blockchain technology and run on the Ethereum network. Ethereum is a DIY platform for the decentralized programs or Dapps whose own currency is Ether (ETH). The Ethereum accounts can hold funds and additionally can send or refund them based on specific conditions. When smart contracts are live, it is impossible for anyone to alter that and thus, it will always run as it had been programmed.
Take for example, there are two accounts – Account “X” and Account “Y”. On a particular day every week, a certain sum of money is transferred from Account X to Account Y. This will continue to happen as long as Account X has sufficient funds to transfer to Account Y. It is impossible for one to change the smart contract and add another Account “Z” as a recipient for stealing funds.
The smart contracts are also made public for anyone who can inspect and audit. This implies that the bad contracts will mostly come under the community scrutiny very easily. This indicates that presently there is a need to rely on the Ethereum community capable of reading codes. The open source based communities aid in keeping the developers in check. But, over time this need will diminish as the smart contracts become much easier to read and alternate ways of proving trustworthiness of codes are developed.
Where Did DeFi Emerge From?
The term “DeFi” has been widely known to the mass in the summer of 2020, but its trails are rooted back during the period of Bitcoin. Bitcoin is inherently decentralized by its design. It had brought about the idea of DLT as a mode of creating decentralized networks for the people to conduct transactions.
When Bitcoin had been launched back in 2009 by Satoshi Nakamoto (an anonymous cryptographer), people had commenced transacting on a decentralized peer-to-peer (P2P) network. This network had been created based on cryptography for the very first time. It utilizes the blockchain that has led to the development of the cryptocurrency ecosystem worth a trillion dollars that we see today.
In just over a decade, Bitcoin has created an entirely new financial system worth over $800 billion and the latest economic ideals set based on liberty and transparency.
Satoshi Nakamoto had visioned to restore freedom to the people via a peer-to-peer financial system. Bitcoin had been the very first digital currency to achieve this vision but is just an example. While Bitcoin serves as the pillar of DeFi, it has only been the entire story’s initial chapter. Following 2009, the other networks had also started developing a similar vision for building a brand new financial system.
What Are The Key Benefits of DeFi?
There are basically five major benefits of DeFi:
- Security: On splitting up everything, the system tends to lose many of its weak points receiving several redundancies.
- Cost-Effectiveness: As the Dapps is capable of offering services autonomously, they offer them at a much cheaper rate than their central equivalents.
- Programmability: The highly programmable smart contracts automate the execution enabling curation of digital assets and new financial instruments.
- Immutability: Security and auditability gets increased using tamper-proof data coordination across a decentralized architecture of a blockchain.
- Transparency: Every transaction on the public Ethereum blockchain is broadcasted to and verified by the other users on the same network. This transparency level involving the transaction data permits rich data analysis and ensures that the network activity is available to all users.
- Interoperability: The composable software stack of Ethereum ensures that DeFi applications and protocols are built to complement and integrate one another. DeFi offers the product and developing teams to enjoy the flexibility for building on top of existing protocols, integrate the third-party applications and customize the interfaces.
- Permission-less: Anyone can access the DeFi applications built on the Ethereum if they possess a crypto wallet and an active internet connection. Often they do not require any minimum funds or a specific geographical location to start with. This is impossible with traditional finance. DeFi is open and permissionless.
- Self-Custody: The permissionless financial protocols and applications require Web3 wallets to interact. The participants of the DeFi market always keep custody of their stored assets and even control their personal information.
Where Is DeFi? How Can I Access It?
The widely used and prominent blockchain is Ethereum. This is the place where the majority of the DeFi applications are based. In the Ethereum blockchain, transactions worth billions occur each week. The Ethereum network has often been termed as the “next internet” owing to its ability to decentralize several services, especially the financial ones. It brings together most of the communities worldwide.
Among the hundreds of decentralized applications called the dApps made available on the Ethereum blockchain, the top ten account for over one million monthly users. The network consistently draws attention to a 24-hour trading volume of over $35 billion.
The Ether crypto coin (ETH) serves as the fuel for the network as every transaction lures a fee utilized to incentivize all those building and maintaining the network.
The fast increasing number of users to the Ethereum network pairing up with the steep increase in the Ether cryptocurrency price has caused a hike in the gas fees charged for making the transactions. The network undergoes a primary limitation: the scalability issue with its transition to the next version of Ethereum in 2021, i.e., Ethereum 2.0.
Why Is Ethereum The Perfect Foundation For DeFi?
Quite a few number of reasons support the fact that Ethereum is the apt foundation for DeFi. Below are the best reasons:
- Ethereum is autonomous, meaning that it is not owned by any group, organization or individual. This states that no one has the rights and scope to alter the rules on you.
- The DeFi products are all based on Ethereum. This ensures that all the products work simultaneously and seamlessly. It enables you to lend tokens from one platform and exchange the tokens with interest in a different platform or market on a completely different application. This is equal to cashing out loyalty points at your bank.
- The cryptocurrency and tokens are built into Ethereum, which is a shared ledger that keeps track of the transactions and the ownership.
- Ethereum permits the complete financial liberty which means that most of the products will never take over the custody of your funds and thus leaves you in control.
DeFi can be assumed in various layers such as –
- Blockchain: Ethereum bears the transaction history along with the state of accounts.
- Assets: Ether (ETH) and other currencies or tokens.
- Protocols: The smart contracts that furnishes the functionality such as a service that permits decentralized lending of assets.
- Applications: Products we utilize for managing and accessing the protocols.
What Activities Can You Perform With DeFi?
DeFi is a decentralized alternative for most financial services. However, Ethereum also curates opportunities for constructing brand new financial products and the list is ever-growing:
- Access Stablecoins: Volatility of cryptocurrencies is problematic for many of the financial products and general spending. The DeFi community has completely solved this with the help of stable currencies or stablecoins. Their value remains pegged to another asset, commonly with a popular fiat currency such as dollars. Stablecoins such as Dai or USDC possess a great value that remains within a few cents of a dollar. This makes these coins perfect for retail or earning. Many Latin American people had used the stablecoins as a means of protecting their savings when there is uncertainty with their government-issued fiat currencies.
- Borrow Funds With Collateral: Borrowing currencies from the decentralized providers mainly comes in two varieties –
- Peer-to-Peer which means that a borrower will directly borrow from a specific lender.
- Pool-based enabling the lenders to provide liquidity or funds to a pool from where the borrowers can borrow.
In today’s scenario, borrowing and lending money revolved around the individuals who are involved. The banks require you to know if you are willing to repay a loan before you lend. The decentralized lending performs without both of the parties having to identify themselves. Instead of this, the borrower needs to put up collateral for the lender to receive automatically if they fail to repay their loans. Some of the lenders do accept NFTs as collateral. NFTs are usually a deed to a unique asset. This permits one to borrow money without the need for credit checks or handing over the private data.
- Borrow Funds Without Collateral: These are basically flash loans that are more experimental for the decentralized lending that permits you to borrow without the collateral or offering any personal information. These are not broadly available to the non-technical people at the moment. But they give an insight that it might be available to everyone. It works on the simple logic that the loan is taken out and repaid within the same transaction. If the repayment could not be completed, the transaction reverts back and poses as nothing has happened.
The funds that are mostly used are held in the liquidity pools, which are big pools of funds utilized for borrowing. If these funds are not used at a given period, it creates an opportunity for someone to borrow these funds and conduct businesses with the funds. They repay them in full literally at the same time they are borrowed. This indicates that a lot of logic is included in bespoke transactions.
A simple instance to this might be that someone uses a flash loan to borrow the required asset at one price so that they can sell it on a different exchange where the price is relatively higher.
Thus, in a single transaction, the following thing occurs:
- You borrow ABC amount of $asset at $1 from exchange “X”
- You sell the ABC $asset on exchange “Y” for $1.10
- You repay a loan to exchange “X”
- You hold the amount (profit minus the transaction fee).
In case, the exchange Y’s supply drops surprisingly, the user would not be able to purchase enough to cover up the actual loan and that the transaction will fail.
In the traditional finance system, to conduct such a transaction one would require an enormous amount of money. However, these money-making strategies are solely accessible to those having existing wealth. The flash loans are a better example of a future where possessing money is not a necessary prerequisite for making money.
- Commence Crypto Savings: Two segments combined form the crypto savings viz., lending and no-loss lotteries.
- Lending – You can have an opportunity to earn interest on your cryptocurrencies by lending it and experiencing your funds to grow in real-time.The interest rates are much higher than that of your local banks.
- No-Loss Lotteries – PoolTogether, a no-loss lottery is an innovative and fun way to save your money. The prize pool gets generated by all of the interests generated via lending the ticket deposits.
- Expand Your Portfolio: The fund management products on Ethereum try to grow your portfolio depending on your chosen strategy. This is open-source, automatic and does not require a human manager to take a cut from your profits. One of the best examples is the DeFi Pulse Index Fund (DPI). This fund rebalances automatically ensuring that your portfolio includes the top tokens from DeFi by the market capitalization. Thus, you never have to manage the details and you may go ahead to withdraw the funds whenever you feel like.Fund Your Ideas: Ethereum is known to be the ideal place for crowdfunding:
~ The potential funders join from anywhere as the Ethereum tokens are available to anyone anywhere in the world.
~ It is transparent, enabling the fundraisers to prove the raised amount of money. One can even trace the way the funds are being spent.
~ Fundraisers get a chance to set up automatic refunds in case there is a specific time limitation where the minimum amount has not yet met.
Quadratic Funding – Ethereum being open-source software, enables the community to fund a lot of work by far. This has paved the way to the growth of an interesting latest fundraising model, quadratic funding. This bears the capability to improve the practice of funding all types of public goods in the future.
The quadratic funding ensures that the projects receiving the most fundings are the ones with the unique demands. To simplify projects that have the capabilities to improve the lives of people. How does it work?
- A matching pool of funds is donated.
- This initiates a round of public funding.
- People can put forward their demand against a project by some money donations.
- As the round gets over, the matching pool gets distributed to the projects. Those projects with the maximum unique demand receive the highest amount from the matching pool.
This implies that Project X having its 100 donations of $1, may end up with even more funding than Project Y having a single donation of $10,000. This is dependent on the size of the matching pool.
- Manage Your Portfolio: With much going on in the cryptocurrency field and with decentralized finance, you would definitely require a route to keep track of all your loans, investments and trades. A couple of products would let you coordinate all the DeFi activity just from a single place. This is the benefit of DeFi’s open architecture. The teams can carve out interfaces where you cannot see your balances across the products but simultaneously use their features. This would become even more interesting as you explore DeFi even more.
- Purchase Insurance: Decentralized insurance focuses on making cheaper insurance with a faster and transparent payout. Having more automation, coverage gets even more affordable while the payouts take a lot less time. The data that is utilized for deciding on your claim remains completely transparent. Similar to any other software, the Ethereum products may suffer from exploits and bugs. Thus, many insurance products in this zone put stress on protecting their users against the loss of funds. However, there are specific projects that have started to build coverages for everything unacceptable and unfortunate. One of the best suitable examples of this is the Crop cover of Etherisc. It aims to defend smallholder farmers in Kenya against flooding and droughts. Decentralized insurance provides cheaper cover for the farmers who are often discarded from the traditional insurance.
- Send Capital Worldwide: Being based on blockchain, Ethereum has been designed to send transactions globally and securely. Like Bitcoin, Ethereum also makes transferring money worldwide much more straightforward, such as sending an email. All you have to do is enter the recipient’s name (ENS name) or their account address from your Eth wallet. Your payment will directly go to the recipient in minutes. However, to send and receive funds, you would need a wallet.
- Stream Capital Worldwide: Interestingly, you are also allowed to stream money over Ethereum. This will enable you to clear the salaries by offering them access to their money whenever they would require it. You can also rent something using the second such as an electric scooter or a storage locker. If you are not willing to stream or send ETH owing to how much its value can change, you can utilize the alternative cryptocurrencies on Ethereum, such as stablecoins.
- Trade Tokens: The traders can get more advanced options and are for the ones who enjoy a little more control. Things that are possible include margin trading, perpetual and limit orders and even more. Decentralized trading enables you to acquire access to global liquidity, the market always remains open, and you always have complete control of your assets.
While utilizing the centralized exchange, you must deposit your assets before the trade and keep faith in them to look after them. When your assets are deposited, they are always at risk as the centralized exchanges remain attractive targets for hackers.
What’s Wrong With Traditional Finance?
The centralized financial systems are vulnerable to hacks, security failures and data breaches, in addition to being slow and expensive to the customers. When the money is in your bank, it decides to up its fees from time to time, gets robbed, makes a bad investment or even collapses. Then, the customer loses out.
However, in DeFi, the applications, products and services along with the assets they service are all decentralized. This means that they are free from the said point of failures that are otherwise found in the centralized financial systems.
The traditional finance systems are inaccessible to millions of people who could not meet the criteria of opening an account in a bank. This might sound awkward to the residents of the developed nations. The insufficient identification and access to the geographic location, capital and government oppression restrict millions of people worldwide from accessing financial services.
DeFi and cryptocurrencies never discriminate and permit anyone having an internet connection to access the financial service equitably, cheaply and easily.
DeFi Vs. Traditional Finance At A Glance
|You hold your assets.||Companies hold your assets.|
|You control the money flow - where it goes and how it is spent.||You have to rely on the companies and make sure they do not mismanage your funds and lend it to the risky borrowers.|
|You enjoy funds transfer in minutes.||Manual process leads funds transfer consume days.|
|Transaction activity remains pseudonymous.||Financial activity is linked to your identity.|
|DeFi is open source and anyone can use it.||You have to apply for using the financial services.|
|The markets remain open throughout.||The markets operate for a stipulated time frame.|
|Transparency is the backbone. It enables others to look at a particular product data and inspect the way the system works.||These institutions are closed books. They do not disclose their loan history or a record of their managed funds and more.|
Top DeFi Tokens of 2021
Amongst a host of DeFi tokens available as of now, a couple of them would be performing great in the coming years. Here, we have enlisted all the tokens that you have to keep a watch on. We will update the list periodically. The tokens and the information shared in this segment is just for the educational purpose and must not be treated as any investment advice.
0x Protocol (ZRX)
Total Supply: 1,000,000,000 ZRX
A DEX liquidity protocol that is utilized to funnel the liquidity to quite a number of different exchanges is the 0x Protocol. It is utilized for governing the protocol alongside being staked by the Market Makers for collecting trading fees.
Total Supply: 16,000,000 AAVE
Aave is one of the leading lending protocols that influences a native token AAVE. This token is used to secure the protocol and as well as participate in the governance. Currently, AAVE is undergoing its migration from the LEND to AAVE at a rate of 100:1. You can also do the same via the migration portal. The DeFi cryptocurrency can be staked through the Safety Module for the AAVE rewards.
Alpha Finance (ALPHA)
Total Supply: 1,000,000,000 ALPHA
Alpha Finance is the yield farming aggregator behind the famous Alpha Homora. Alpha Homora is a product to lend Ethereum used to farm on the leverage. The platform is governed by ALPHA bearing a yield portion that is directed back to a community treasury and managed via governance.
Total Supply: 100,000,000 BAL
Balancer is a liquidity protocol governed by the native token BAL. It is an automated asset management. Its Liquidity Mining program was launched in June. Since then, BAL has experienced rigid growth on all fronts. It is utilized to govern the important protocol decisions such as the support assets, protocol fees and the factors that are relative to how the BAL is earned.
Total Supply: 69,148,554 BNT
Bancor, fueled by the native token BNT is a DEX. A specific portion of the trading fees that are collected from the exchange gets distributed to the BNT holders. Currently, Bancor is rolling out its V2 upgrade introducing BNT staking via a BancorDAO.
Total Supply: 1,030,000,000 BZRX
Torque and Fulcrum use bZx, which is a margin and lending protocol. The project has lately debuted the BZRX governance token having an upgraded token model that is kickstarted by an Initial DEX Offering. bZx is utilized for covering protocol deficits and is staked through the bZxDAO for inflation and trading fees.
Total Supply: 10,000,000 COMP
COMP is the native governance token behind the leading lending protocol. Users earn it for borrowing or lending assets. The DeFi token is used for governing the crucial protocol decisions used to delegate or vote on the Compound Governance Dashboard.
It is allocated to the markets relative to the amount of interest amassed. This means the assets that generate the maximum interest will earn the most COMP on a per-day basis.
Total Supply: 3,030,000,000 CRV
Curve is the liquidity aggregator for the Bitcoin wrappers and stablecoins (same-peg assets). The native coin of Curve is CRV. It is staked through the Curve DAO for both the time-weighted governance and the liquidity multipliers on the CRV liquidity mining. In the near future, it has been hinted that the Curve DAO will utilize the protocol fees for purchasing and burning off CRV from the open market.
Index Cooperative (INDEX)
Total Supply: 10,000,000 INDEX
It is a community governance index management protocol running behind the DPI or DeFi Pulse Index. The governance token, INDEX is utilized for deciding how the indexes are compromised. It also reveals how the assets in these indexes are utilized in the meta-governance of their respective protocols. The team working behind the Index cooperative is the same as TokenSets and Set Protocol.
Kyber Network (KNC)
Total Supply: 210,623,056 KNC
The Kyber Network is a dominant DEX capturing value via a native token known as the Kyber Network Crystals (KNC). The fees that are acquired through the exchange are widely used for burning KNC. Recently, Kyber has undergone the Katalyst tokenomics upgrade. In this upgrade, it has introduced the key governance mechanisms via the emergence of the KyberDAO.
By using the KNC, the users will bear the ability to delegate or vote on the important protocol decisions consisting of the distributing the fees gathered from the DEX trading.
Total Supply: 1,374,513,897 LRC
Loopring can be defined as the Layer 2 protocol offering scalability solutions for optimizing the throughput on Ethereum. Loopring (LRC) is staked for gaining a portion of the trading fees that is earned both on applications such as Loopring Pay and DEX.
Total Supply: 1,005,577 MKR
Maker, the decentralized protocol is responsible for creating DAI. It is utilized for delegating or voting on the protocol decisions via the Maker voting dashboard and is burned utilizing a portion of the Stability Fees gathered from the outstanding loans.
Total Supply: 100,000,000 MTA
mStable is the liquidity aggregator for mUSD and mASSETS (same-peg tokens). The mStable protocol is governed by the native token MTA that can be staked through the Earn feature against a claim on the protocol fees and the MTA inflation. MTA had debuted bearing an Initial DEX Offering. Later it decided to use Mesa for the fair price discovery to refrain from bot front-running.
Nexus Mutual (NXM)
Total Supply: 4,355,684 NXM
Nexus Mutual provides the mutual members NXM in exchange for the ETH that gets deposited to the Capital pool for protecting against the vulnerabilities of smart contracts. If a claim is passed, the ETH from the capital is utilized for compensating the affected party. The members can then stake NXM on several contracts for collecting a portion of the fees that are gained on the covers purchase. In future, Nexus is about to introduce the pooled staking that permits all purchased covers to be allocated across all people that stake their NXM.
Total Supply: 10,979,551 NMR
Numerai is an Artificial Intelligence based hedge fund that is responsible to create Erasure, which is a prediction protocol where the users stake NMR to signal confidence in their predictions. Recently, NMR has been listed on Coinbase.
Total Supply: 100,000,000 DOUGH
An asset management protocol that offers access to different DeFi indexes is PieDAO. The native token of it is DOUGH. It is used to govern the indexes and provide fees to the DOUGH holders as the indexes are traded. Quite a few liquidity mining programs offer DOUGH currently.
Ren Protocol (REN)
Total Supply: 1,000,000,000 REN
An interoperable bridge to port the assets to Ethereum utilizing the RenVM is Ren Protocol. The users need to post 100,000 REN as the collateral for hosting a dark node in order to become a validator on the network. All those that operate on the darknode are offered a pro-rata share on all the trading fees. The fees are collected from the protocol.
Total Supply: 250,000,000 SUSHI
It is the lending protocol and governance token of the Sushiswap AMM. It is earned by the LPs by offering liquidity to the selected pairs on the Sushiswap. It can be staked through the Omaske bar for earning protocol issuance and fees. SUSHI is also utilized to vote on the latest Onsen launch partners or the projects that acquire added SUSHI rewards to conduct an Initial DEX Offering via Sushiswap.
Total Supply: 190,075,446 SNX
Synthetix is a leading protocol for derivatives that has been backed by a native token SNX. For minting new derivatives known as Synths, the users need to stake at the minimum 750% of the Synths value in SNX. cRatio, the maintenance of this ratio permits the users to earn the native inflation alongside a pro-rata portion of the trading fees from the Synthetix Exchange.
Total Supply: 100,224,817 UMA
UMA is a derivatives protocol used for creating permission less synthetic assets. The native token for UMA is UMA. It is used for governing the protocol decisions which can be utilized to challenge the underlying registries that go out of sync with the synthetic asset that they are attached to.
Total Supply: 1,000,000,000 UNI
A leading decentralized exchange in DeFi is Uniswap. Last year in September, Uniswap had airdropped 15% of its supply to the earlier users via a program named “UNIversal Basic Income”. Currently, UNI can be earned by offering liquidity to the selected pools and eventually will be utilized for governance as a relatively larger portion of the supply is issued.
Total Supply: 30,000 YFI
Talking of an automated liquidity aggregator is the yEarn that offers a number of various yield farming opportunities. This protocol is governed by the YFI native token. It was launched having no premine and never held an Initial DEX offering. The users can stake the YFI for participating in governance and also claim a pro-rata share of the protocol fees.
Rise of various token flavors outside the protocol-specific tokens offers a depositor for supplying assets to a DeFi protocol. The examples of these token flavors are as follows:
🔯 cTokens: The ERC-20 tokens that represents an underlying loan being equipped out on Compound Finance. The cTokens gain interest over time depending on the supply interest rate. Thus, each token becomes redeemable into a rising amount of the underlying asset.
🔯 dTokens: Dharma’s token flavor or dTokens that offers the same benefits as the cTokens having 10% of the collected interest being extorted back to Dharma like a revenue stream.
🔯 oTokens: These flavors are options that are offered on the Convexity Protocol and used in the products such as Opyn. while purchasing a put, the users receive oTokens in return.
🔯 tBTC: It is a decentralized and trustless system used for wrapping Bitcoin as proposed by the Cross-Chain Working Group and Keep Project. Bitcoin (BTC) is deposited into a multi-signature wallet where the key holders are incentives to act locking up the other cryptocurrency assets as collateral (ETH in this case). As soon as this is confirmed on-chain, the tBTC smart contract mints the user with an equivalent of token on Ethereum in the ratio 1:1.
🔯 TokenSets: These are Set protocol-based asset management tokens. The investors purchase a single ERC-20 token having programmable trading strategy and the underlying components such as cUSDC and ETH.
🔯 wBTC: It is a multi-institutional framework used for wrapping Bitcoin on Ethereum via the use of Custodians and Merchants to burn, issue and custody of the underlying assets.
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