What is decentralized finance (DeFi)?

Recreates traditional financial systems in a decentralized manner using smart contracts (automation in place of middlemen)

Examples: lending, borrowing, derivatives, exchange

Financial building blocks or “money legos” can create more complex capabilities

Image source: https://medium.com/totle/building-with-money-legos-ab63a58ae764

Almost $80 billion locked in DeFi

Image source: https://defipulse.com/

Stablecoins

Not ideal in all financial transactions to use a cryptocurrency that has price volatility e.g. taking out a loan

Stablecoins aim to reduces price volatility (many pegged to USD)

Centralized stablecoins backed 1:1 by fiat in a bank account e.g. USDC

Decentralized stablecoins can be crypto collateralized or algorithmic

Image source: https://medium.com/ethex-market/which-stable-coin-is-best-for-you-2167d0d9f520

Maker

Decentralized stablecoin on Ethereum that is overcollateralized by crypto

Stablecoin DAI can be minted by anyone through locking up crypto as collateral to take out a DAI loan e.g. lock up $200 of ETH to borrow $100 of DAI

If price of collateral drops, then assets are seized and liquidated

Common use case is leverage

Image source: https://makerdao.com/

Decentralized lending and borrowing

Lend or borrow directly from smart contract

Some have interest rates that dynamically change based on supply and demand e.g. Compound and Aave

Provide collateral in crypto in order to borrow funds (loan needs to be overcollateralized)

Image source: https://loanscan.io/

Decentralized exchange (DEX)

Anyone can trade assets that conform to token standard (e.g. ERC-20, ERC-721)

Can have decentralized order books that look like traditional exchange e.g. 0x, dYdX

Automated market maker (AMM) provides pricing algorithmically based on liquidity available and will always provide a price e.g. Uniswap, Sushiswap

Aggregators pull liquidity from all e.g. Matcha, 1inch

Image source: https://app.uniswap.org/#/swap, https://medium.com/scalar-capital/uniswap-a-unique-exchange-f4ef44f807bf

Over $60 billion in monthly DEX volume

Image source: https://duneanalytics.com/hagaetc/dex-metrics

Token governance

Token holders vote on direction of project or various parameter settings e.g. Maker (MKR) holders can vote on parameters such as fees charged

Can be referred to as a decentralized autonomous organization (DAO)

Image source: https://vote.makerdao.com/polling

Liquidity mining

Projects distribute governance tokens to community

Often reward adding liquidity through “liquidity mining”

Different levels of rewards based on requirements e.g. lock up for longer, reward vesting, retroactive rewards

Image source: https://curve.fi/

Flash loans

Someone can borrow funds and repay in same transaction

If not repaid in same transaction, then it fails

Enables uncollateralized loans

Common use case is for arbitrage opportunities in DeFi

Image source: https://etherscan.io/tx/0xb5c8bd9430b6cc87a0e2fe110ece6bf527fa4f170a4bc8cd032f768fc5219838

Composability with DeFi

Interesting possibilities when combining DeFi building blocks or “money legos”

For example PoolTogether is a “no-loss” lottery: users purchase tickets and all proceeds go into a prize pool that earns yield from DeFi protocols Compound and yEarn vaults. Everyone gets funds back but one person wins all of the interest on pooled money

Image source: https://pooltogether.com/

Composability with DeFi and NFTs

Interesting possibilities when combining DeFi building blocks and NFTs

For example, NFTFi allows you to use NFTs as collateral in taking out a loan ranging from wallet names to virtual land

Image source: https://nftfi.com/