DECENTRALIZED FINANCE (DeFi)
DeFi has been in the spotlight in recent days. Before investing in them, it is imperative that we fully understand what they really offer.
OVERVIEW
When we talk about economics, we always think of the best mechanisms to create prosperity among nations and individuals. One of the fundamental elements occurs within the financial markets that, in one way or another, create conditions to boost finances; However, most of the ecosystem is concentrated in those who move large capital and profits, that is, it remains in the hands of a few. In this sense, in the last decade, we have had an increase in the development of financial products, mainly after the crisis of 2008, when the Fintech ecosystem had an accelerated evolution thanks to digitalization and the interest in creating new options to capitalize.
This new digital financial scheme gave people a kind of empowerment in their financial decisions; However, large capital and financial products continued (and continue) to be concentrated in organizations in charge of safeguarding and managing money. To a large extent, traditional finance is the backbone of the economy internationally; however, they belong to a closed system, that is, centralized. Despite this, the outsourcing paradigm had a turning point with the emergence of one of the greatest phenomena in history: bitcoin. We know that bitcoin is controlled by a network of users that does not belong to anyone, its governance is based precisely on a system where all people can be part of that network. With bitcoin, not only was a system of value transfer safely created through the internet, but it also gave strength to one of the concepts that cypherpunks and crypto-anarchists longed for 4 years: decentralization within the financial system, that is, the total elimination of intermediaries in finance.
CONCEPT & FEATURES
The concept of financial decentralization is frequently related to the crypto assets industry due to the particularities that blockchain technology offers. Although there are different definitions, probably the one that best suits is the one that refers to a financial system focused on the development not only of cryptocurrencies but also on the creation of other financial products such as loans, investments, or trading through technological platforms that offer their products without the need for a third party to validate operations, such as banks, for example).
One of the peculiarities of the DeFi system is that it has open-source protocols for the construction of other financial products accessible to all people and not just cryptocurrencies. In this sense, DeFi protocols are characterized by being:
Interoperable: its functionalities are not in a closed environment, that is, they are not isolated. To exemplify, in a centralized system, there may be certain types of locks, such as the region or nationality of an individual, their income, and so on. In the interoperability of the DeFi scheme, these variables are not transcendent, only transactions matter.
Programmable: The agreements are made through smart contracts that already include automated conditions.
Composable: Resources can be combined to build other new products and are managed through the protocol.
Most of the DeFi protocols use smart contracts based on the Ethereum network. Some existing products on the market are:
Decentralized exchange platforms ( DEX ) like Uniswap, 0x, and Kyber Network.
Stablecoins ( DAI and USDC, with a reliable value for hedging and transfer).
Automation for asset management (Set Protocol, which offers a decentralized equivalent to ETFs allowing the creation of an ERC20 token that represents multiple tokens in one).
Trade Margin (DyDx allows users to borrow and place bets on the future prices of popular cryptocurrencies).
Tokenized debt platforms (Dharma allows the sending and receiving of USD, in addition, returns can be generated on the platform with rates of 2.5%, a bank account is not required to use it and it is 100% free).
Insurance (Etherisc, a decentralized insurance protocol for collectively building insurance products that enable users to protect themselves from risks they face in DeFi).
LIQUIDITY MINING
Liquidity Mining is a new way to receive returns and profits in governance tokens of different DeFi protocols. This mechanism is used as an incentive for users to participate and provide liquidity to the different protocols of the DeFi ecosystem. Recently, DeFi projects in the Ethereum ecosystem experienced a bull season, surpassing $ 3.5 billion in tokens locked across the ecosystem. This incredible increase is due in large part to the new mechanism that was recently used known as Liquidity Mining or liquidity mining.
Thanks to the incentives established under this mechanism, Compound recently managed to get 38% of the total value blocked in DeFi platforms, even surpassing MakerDAO, a project that remained the undisputed leader of the ecosystem until just a few weeks ago.
The creation of cryptocurrencies brought with it the implementation of new concepts within the financial sector. For example, Bitcoin Mining, Decentralized Autonomous Organizations, Decentralized Finance, and now the concept of Liquidity Mining are some examples.
It is important to note that this last concept has a certain relationship with the mining that occurs within large cryptocurrencies such as Bitcoin or Ethereum.
In other words, Bitcoin miners make their computational power available to the system to carry out the mining work; a job that since the creation of Bitcoin in 2009 has not been broken, which is why it is considered one of the safest systems that exist until now and that gives you the high value that the BTC cryptocurrency enjoys today.
With Liquidity Mining, users must not have a mining platform or software but simply must have an inventory of blocked cryptocurrencies or tokens. This means that users who want to participate in Liquidity Mining have to leave an inventory of assets such as investment capital locked within some DeFi protocols to offer liquidity to a specific token or basket of tokens.
THE FIRST DeFi PROJECT
The balancer was one of the first DeFi projects to implement Liquidity Mining. To do so, the team designed a protocol that operates as an exchange for the decentralized exchange of various cryptocurrencies. However, as this protocol is a bit complex for the general public, Balancer another tool designed for easy use and access for all known as pools of liquidity (liquidity pools).
These pools of liquidity work thanks to the fact that several users deposit their ERC-20 assets or tokens within a smart contract where they will remain blocked for as long as the user wishes. Through these assets, other users can start trading or exchanging their respective assets by interacting directly with Balancer smart contracts.
MONEY ON CHAIN
Money on Chain is a DeFi protocol that uses 3 types of tokens to obtain greater stability against the dollar, to leverage a BTC position, and to exchange cryptocurrencies. Soon, this protocol will launch its MoC governance token, which can be obtained by providing liquidity to the protocol.
In addition, it is important to mention that there is still no clear regulation on the legal status of these protocols, so at any time it is possible that a government or group of governments will start taking actions against DeFi projects.
On the other hand, it has been shown that DeFi users are taking leveraged positions and then blocking their crypto assets in different projects in order to request new loans in other assets and take advantage of the incentive generated by Liquidity Mining to obtain high returns from this operation, which starts a complex cyclical process.
In short, a user can lock his Ether as collateral within a protocol like MakerDAO to request a loan in DAI, which is a stable coin indexed to the dollar. Then, the same user uses that loan in DAI to block it in Compound and use it as collateral to request a new loan with another asset, and so on, the whole process is repeated cyclically.
CONCLUSION
Decentralized finance represents a paradigm shift from the current system and offers new possibilities that were previously unthinkable. Mechanisms such as Liquidity Mining allow the design of new incentive models to remunerate people who contribute to the success of new projects. Just as there are exciting investment opportunities for people who understand technology, there are also many risks that are important to understand in order to get the most out of this revolution.
