In Part I of the DeFi series, we defined decentralized finance and outlined the differences between centralized and decentralized financial systems. In Part II, we discussed the benefits of decentralized finance in detail. In this section, we will analyze the DeFi use cases. Welcome on board, and we hope you will benefit from this discussion.
Decentralized Finance (DeFi) use cases
Crypto lending and borrowing
DeFi lending platforms offer loans to users in a trustless way- without third parties. The platforms also allow users to earn interest on staked coins. The Ethereum and EOS blockchains dominate the DeFi lending marketplace. Although most DeFi lending applications are built on the Ethereum network, EOS has the highest amount (more than $600 million) locked by a blockchain. Since cryptocurrencies tend to have high price volatility, most lending platforms require borrowers to supply an average of 150% collateralization to qualify for a loan.
The lending and borrowing platforms have several benefits for market participants. For borrowers:
Ability to short an asset. Borrowers can purchase digital assets and immediately trade them on their favorite exchanges for other cryptocurrencies, thus shorting the asset.
Borrow a utility. A borrower can choose to temporarily borrow a token to earn certain privileges on a blockchain network, like governance rights.
Long-term investment reward. Long-term investors can gain interest on lent assets and capital appreciation or a HODL strategy.
Stablecoin issuers can also earn incentives by distributing their revenue from floating interest rates obtained from their bank deposits to customers who support the circulating supply.
Examples of DeFi lending and borrowing platforms include Dharma, Compound, Maker, Nuo Network, ETHLend, and others.
A derivative is a financial contract between two or more parties that derives value from the performance of an underlying entity, like assets, interest rate, bonds, commodities, etc. DeFi derivatives bring significant flexibility across different assets and platforms. There are two main functions of derivatives:
To protect oneself from price fluctuation in the future by signing a contract to purchase an asset at a fixed price.
To gain profits by speculating how the price of that asset is going to perform in the future.
Types of derivatives
Future. A buyer purchases an asset at an agreed-upon rate on a fixed date in the future. Futures are mostly traded on exchanges.
Forward. It is similar to a Future, but it is more customizable and flexible to fit both entities.
Option. A buyer enjoys the right to trade the underlying asset at a specified price, but they are certainly not obliged to.
Swap. It allows two parties to exchange one type of cash flow for another- normally between a fixed and floating flow.
Examples of DeFi derivative platforms include LedgerX and Bakkt.
Asset management tools/DeFi wallets
DeFi wallets provide crypto custodianship, but they are specialized financial institutions that safeguard customers’ assets and they are not linked to the traditional financial system.
Cryptocurrency gateways interacting with Web 3.0 must prioritize security, intuitiveness, and accessibility for users, and provide them with full control. Asset management tools, like non-custodial wallets, are integral in the adoption of Web 3.0.
Examples of DeFi wallets include MetaMask, Brave, Coinbase wallet, MyEtherWallet, Trust Wallet Gnosis Safe, and others.
DeFi insurance protocols enable users to apply for insurance policies on smart contracts, funds, or any other virtual asset via pooling individual funds to cover any claims. While the crypto-insurance sector is at its infancy stage, the market is untapped and as the demand grows, more insurance apps would emerge.
Examples of DeFi insurance protocols include Nexus Mutual, Ethersc, Cdx, etc.
DeFi is focused on providing financial services distinct from the traditional financial system. This allows for a more open financial system, which will potentially reduce the incidences of censorship and jurisdictional restrictions all over the world.
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