DeFi stands for “decentralized finance” and refers to an ecosystem consisting of financial applications built on top of blockchain systems.
Decentralized – Without a central authority or managing system
Also described as a concept that facilitates decentralized networks and open-source software to build different types of financial products and services, DeFi realized the development of decentralized financial apps (DApps) with blockchain technology. We will compare Decentralized Exchanges (DEX) and Centralized Crypto Exchanges (CCE) as we go on in this article.
To understand DeFi, one must understand the mechanisms of blockchain.
Blockchain is a decentralized ledger of transactions across a peer-to-peer (P2P) network without a central certifying authority.
- P2P refers to a group of linked computers (nodes) with equal permissions in data processing
- A technology where blocks of information falls chronically onto a chain.
- The blocks store crucial transaction information such as date and time
- The blocks store information that distinguishes itselves from other blocks
- Immutable (Cannot be altered)
Essentially, blockchain technology plays a pivotal role in the world of DeFi. DeFi makes use of blockchain to create financial offerings through smart contracts.
How Smart Contracts Complement DeFi
Smart contracts are self-executing contracts with purchase terms of agreements written directly in computer code and render transactions irreversible, transparent, and traceable.
DeFi decentralizes, making operations fully autonomous. Thus, the self-executing nature of smart contracts removes intermediaries for contract signing. Smart contracts also reduce risks and can be more convenient and reliable than traditional contracts.
DeFi Disrupting Traditional Finance
DeFi has disrupted traditional finance – Where central certifying authorities like central banks are required to print money (Currencies) in transaction facilitation. We should also understand that currencies are created for transactions to improve economic productivity. DeFi decentralizes centralized operations by creating open, global, and accessible alternatives (with an internet connection) to every financial service in modern days – think loans and insurance. Cryptocurrency, as an arm of DeFi improves economic productivity as autonomy speeds up transactions.
Traditional finance was first disrupted 11 years ago with the invention of the first major cryptocurrency, Bitcoin. Cryptocurrency also paved the way for DApps when it took off with DEXs.
DeFi is sometimes referred to as “Lego Money” because DApps can be stacked on top of one another to maximize returns, where not possible in a CCE. In a CCE, one will not have full custody of h/her assets, security may be compromised, and fall victim to system manipulation by the exchange. However, despite the risks, a CCEprovides high liquidity and volume that will benefit traders. CCEs are also more beginner-friendly compared to DEXs, where one can incur significant losses from carelessness, to be explained further below.
The Bad of Dexs
The benefits of DeFi did not come without its faults. DeFi promotes autonomy, which can be a boon for many who prefers independence. However, this also meant that should users not be careful enough, they will lose their assets and money.
A CCE protects your information with proper security measures in place. In a DEX, you are your security. Lost private keys, passwords, or wrong addresses are common error occurrences in DeFi that has resulted in big losses for users.
Unexpected bugs and technical issues from smart contracts also compromises the safety of one’s assets, i.e. The DAO attack where a hacker stole more than $50 million of digital currencies.
Pros of DeFi
Again, DeFi is about autonomy – This means that intermediaries or arbitrators are excused. Users of DEXs have full control of their funds as the code defines the settlement of any future disputes, reducing costs associated with asset management (i.e. Brokers). Single points of failure from a centralized system are also eliminated as data is recorded on blockchain. DeFi is transparent as data is publicly available and individuals may check reserves of a DeFi bank for rates and transaction data.
DeFi further counters the pain points of individuals’ inaccessibility to central banks in some developing countries. Often, intermediaries like traditional banks take a commission from individuals, which is less than ideal for low-income earners.
Comparing DEX & CCE
|Trade Volume||High||Low||DEXs are not user-friendly with limited functions|
|Exchange||Fiat & Crypto||Crypto|
|Payment||Bank wire transfers, credit & debit cards||Crypto|
|Safety||More prone to hackers||Less prone to hackers||DEX’s distributed nodes makes it less prone to hacking|
|Infrastructure Risks||Depends on how advanced the central management is with platform development||Low to no risks||DEX’s distributed nodes makes it less prone to infrastructure risks|
|Privacy||Low||High||Often users are required to go through KYC procedures with CCEs. Data may be compromised should the KYC system of the CCE not be robust enough.|
|Other Services||Variety||Solely trading service|
Why the Recent DeFi Hype?
The recent hype of DeFi came about as Covid-19 slapped the world’s financial system with issues from value decrement in fiat currencies that has resulted in a loss of public confidence. People are seeking alternatives to the traditional banking system and are turning to DeFi products like cryptocurrencies.
The US Securities and Exchange Commission (SEC) are embracing DeFi by approving an ethereum-based fund, Arca, in July 2020 – A sign of financial innovation acceptance. In traditional unsecured lending, borrowers and lenders must know one another’s identities and lenders must assess whether a borrower is credit-worthy. Such tedious processes have ideated the selling product of DeFi, crypto loan.
The automated system in DeFi quickens the process of borrowing. Global job losses have rendered many non-creditworthy, resulting in possible poor cashflow from sustaining pre-covid commitments (Car, housing etc). People can now borrow money instantly with DEXs without the need for income documents or Know-Your-Customers (KYC) processes. Additionally, users can earn from crypto loans with margin trading. As earlier mentioned, while there are system manipulation risks from CCEs, one should always be cautious with personal private keys to prevent assets loss when using Dexs.
Major financial institutions are also beginning to get involved in DeFi with 75 world biggest banks testing on blockchain to speed up their payment processes, as part of the Interbank Information Network. In addition, big players of asset management funds like Grayscale have also jumped on the DeFi bandwagon as it managed over US $5.2 billion of cryptocurrencies in the first half of 2020.
Jumping on DeFi
We compared CCEs and DEXs and both have their pros and cons. In fact, the painpoints of both may be countered by respective pros. Good news – beginners who wish to jump on DeFi may look for DeFi tokens listed on CCEs. DeFi Liquidity Mining Funds also open the doors to DeFi and users may potentially earn 40%-100% of passive income.
To aid in your token selection, users can check out top performing DeFi tokens by market capitalization according to CoinMarketCap, world’s most-referenced cryptoasset price-tracking website, here.
DigiFinex recently launched spot trading for DeFi and have listed selected quality DeFi tokens:
- Compound (COMP)
- 0x (ZRX)
- Ren (REN)
- Chainlink (LINK)
- Maker (MKR)
- Dai (DAI)
- JUST (JST)
- Basic Attention Token (BAT)
- Augur (REP)
- dForce (DF）
- USDX (USDx)
- Aave (LEND)
- Synthetix (SNX)
- Kyber (KNC)
- JackPool.finance (JFI)
- yearn.finance (YFI)
- DFI.money (YFII)
- Loopring (LRC)
- Balancer (BAL)
- Numerai (NMR)
- Reserve Rights Token (RSR)
- Bancor Network Token (BNT)
- Sushiswap (SUSHI)
- GOLDX (GOLDx)
- Autonio (NIOX)
On-going Promotional Trading Event
- Event time: 14 Sep 2020 11:00 – 27 Sep 23:59 (GMT + 8)
- Promo: Users can get a 50% discount by trading any token in the DeFi section
- Rewards distribution: Rewards will be distributed in 5 working days after this event ends
Even better news, DigiFinex is due to launch its very own DeFi Liquidity Mining Fund, where users can stake on other assets for specified tokens and earn maximum rewards from high liquidity – Sounds promising, yes?
DeFi’s innovative features have emerged as an essential cornerstone of the crypto space. The recent DeFi hype has demonstrated that the marriage of blockchain and crypto are bound to scale new heights and enable wider global accessibility to financial services with more major financial institutions picking up on decentralized ecosystems.
For related articles, read DigiFinex Academy.