DeFi is a relatively new trend in the world of cryptocurrencies, which appeared in 2017 and developed significantly in 2021-2022. The first projects were launched on the Ethereum platform, and a little later other blockchains were added - BNB Chain, Polkadot, Solana, Polygon, NEAR Protocol and others.

What is DeFi

Decentralized finance (DeFi) is an alternative to the traditional financial system implemented in the cryptocurrency industry. This is a distributed infrastructure with many online projects that integrate with each other to one degree or another.

The main idea of ​​DeFi is to create an analogue of traditional financial institutions, such as banks, exchanges, investment funds and others, but on the principle of decentralization, that is, so that the entire system is under the control of users, and not of central management. As a rule, projects are open source, and all processes involve special mechanisms based on blockchain technologies, for example:

  • digital assets (coins and tokens);

  • wallets;

  • distributed registries;

  • smart contracts;

  • oracles;

  • decentralized applications, etc.

Thanks to the combination of such instruments, it was possible to implement new financial services that did not previously exist. But the DeFi market is at the very beginning of its development, and there are a number of difficulties that have not yet been resolved:

  • Many services are inconvenient to use and require certain skills from the user.

  • The lack of legal regulation creates some problems for users and companies.

  • Sometimes cases of fraud and theft of funds occur, which indicates security problems.

Distributed ledger technology itself has maximum reliability if used correctly. Security issues mean the lack of tools to protect inexperienced users. Therefore, DeFi needs to be refined and developed to make the conditions for its use more favorable.

DeFi: what is it in crypto

It is obvious that in the future many innovative projects will be created based on this technology, but already now there are several areas that have gained high popularity in the cryptocurrency community.

Decentralized Exchanges (DEX)

This is an important part of the decentralized finance market. DEX exchanges allow you to trade cryptocurrencies without having to trust your funds to centralized organizations.

Such platforms operate on the blockchain and allow traders to conduct transactions directly between accounts. To start trading, you do not need to go through registration and verification; you just need to synchronize your wallet with a smart contract. In other words, users can maintain their anonymity.

But decentralized exchanges also have disadvantages. One of the main ones is low liquidity compared to centralized platforms. Because of this, traders may encounter certain difficulties:

  • Inability to buy the required number of tokens because there are not enough sellers on the exchange.

  • Inability to sell assets because there are not enough buyers.

Such difficulties are partially solved thanks to aggregators that collect liquidity from several exchanges. But even they do not always allow you to carry out a transaction for a large amount.

However, as the market develops, decentralized exchanges gradually improve functionality. Their demand is increasing and they are becoming an important element in the future of the financial industry.

Decentralized cryptocurrency lending

There are DeFi services that allow you to take out loans. As a rule, to do this, you need to provide cryptocurrency as collateral, and you can borrow stablecoins.

Such lending has a number of advantages over similar services of traditional banks:

  • no need to provide documents;

  • money arrives instantly;

  • the loan can be taken out for any period;

  • interest rates are significantly lower;

  • The debt can be repaid in any installments and at any frequency.

To take out a loan, you must complete the following steps:

  • synchronize your wallet with a special smart contract;

  • indicate the desired conditions - amount, collateral asset, etc.;

  • confirm the transaction on the blockchain.

After this, the coins that are provided as collateral will be withdrawn from the borrower’s account, and stablecoins will be received in return. In most cases, the value of the collateral exceeds the loan amount by 10-50%.

A logical question arises: why take out a loan if you can simply sell cryptocurrency and get money? The fact is that traders and investors actively use such services to hedge risks.

Let's imagine this situation:

  • The investor has 10 ETH.

  • At the current rate, 1 ETH costs $2000.

That is, the total amount of assets is $20,000. The user believes that ether will increase in price in the future. But now he needs money for some purposes - for example, to trade in the market. Then he can take out a loan against his ETH.

If, according to the terms of the platform, the value of the collateral must exceed the loan amount by 50%, the investor will receive a loan of 10,000 USDT for his 10 ETH. The situation may then develop as follows:

  • If the ETH price rises to, for example, $3,000, the investor will be able to pay 10,000 USDT to get back his ether, which is already worth $30,000.

  • If the rate falls below $1000, the position will be automatically liquidated. As a result, the lender will receive 10 ETH, and the borrower will remain with his 10,000 USDT. The liquidation threshold depends on the terms of the specific service.

Thus, if the coin rate rises, the borrower will receive all the profit, and if it falls, he will partially fix his position. At the same time, you can use the money received on credit at your own discretion.

As for the commission for using a loan, for stablecoins it rarely exceeds several percent per annum. This is much more profitable than in banks. Lenders, in turn, can use an analogue of a bank deposit with increased investment interest. As a result, both counterparties receive favorable conditions due to the absence of an intermediary.

Pharming (staking)

Pharming is the process of making money on DeFi services by transferring your assets for temporary use. These include the following options:

  • investments in liquidity pools of DEX exchanges;

  • issuing loans in digital assets;

  • buying and holding some coins.

An investor can receive rewards in native tokens or in those assets that he lends, depending on the terms of the project.

The profit margin also fluctuates quite a bit: it primarily depends on volatility. For some coins, 100% per annum is far from the limit. But such a cryptocurrency can fall significantly in price against the dollar, and then the investor will receive a loss even taking into account the accrued interest.

In addition, to participate in some pools it is necessary to freeze two different assets at once. In this case, a “non-permanent loss” may occur when, due to the correlation of rates, not only the value decreases, but also the number of coins that can be received back. Therefore, the investor must clearly understand what he is doing and be aware of his risks.

Other DeFi projects

There are projects on the DeFi market that are not so popular yet, but also offer fairly high-quality services, for example:

  • Insurance. Protection against possible losses associated with investing in cryptocurrencies.

  • Decentralized futures and options.

  • Synthetic tokens. They allow you to make money on fluctuations in the price of an asset - not just a digital one - without the need to purchase it.

  • Payment networks. These are various add-ons to speed up and/or simplify financial transactions.

  • Prediction markets. They allow you to predict various events and make a profit for it.

  • Oracles. They act as a bridge between the native blockchain and external networks or off-chain applications.

  • Decentralized identification. Allows you to save personal data and present it in encrypted form to undergo verification without revealing your identity or with partial disclosure.

  • Investment funds. An analogue of centralized funds that work in the DeFi field according to pre-established algorithms.

  • Decentralized auctions for trading unique NFT tokens.

Such services expand the capabilities of the decentralized financial system and offer unique solutions for various tasks. But when choosing a DeFi project, you need to be careful and aware of the risks. It is important to consider its functionality, security, reputation and transparency of operation.