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DeFi 101

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DeFi 101

What is DeFi?

De - Centralized Finance

A movement to create a new financial system that is open to everyone and does not need one to depend on intermediaries like banks. Permissionless and Open

Relies heavily on : Cryptography, Blockchain and Smart Contracts (main building block - piece of code that can be executed automatically in a deterministic way)

Most DeFi projects are built on Ethereum - fairly robust, allows for writing advanced smart contracts and has the most developed ecosystems

DeFi Components:

  • Decentralized Infrastructure : Ethereum (Ether is compatible with Ethereum but very volatile)
  • Decentralized Stable Money (DAI): To build a reliable financial services, we need something more stable currency; Stable Coin: pegged to the value of a real world currency
  • Decentralized Financial Services: (DEX), money markets

One of the first projects: MakerDAO

User locks in Collateral in exchange for stable coin called DAI

  • follows the price of US Dollar
  • Other stablecoins are backed by US Dollar reserves. DAI is backed by crypto collaterals
  • Overcollateralized (covers for ETH volatility)
  • DAI is a smart contract built on Ethereum Platform

Can be used for Savings on Makers Oasis platform

Pillar of Centralized Finance : Lending and Borrowing

Parts of the DeFi Ecosystem

DEX:

  • Built on Ethereum Platform
  • Allows users to buy sell or trade cryptocurrencies without a central authority
  • No accounts, no verification,
  • 2 Types: Liquidity Pool Based (UniSWAP) and Order Book Based (IDEX)

Decentralized Money Markets

  • Connect borrowers with lenders
  • Borrow against crypto collateral
  • Autonomous management of loan terms

Stablecoins:

  • Algorithmic: DAI
  • Non-Algorithmic: USDC, USDT, PACs: Centralized as there is a company that needs to hold equivalent US Dollar

Oracles:

  • Deliver reliable data feeds from the outside world into smart contract
  • Trusted sources that become a bridge between real world and crypto world

What are StableCoins?

  • It’s a utility token built on another coins blockchain
  • Cryptocurrency that is NOT VOLATILE

Stablecoin is pegged to the US Dollar and equals $1

  • How Trading works without Stablecoin?
  • Sell etherium on Coinbase >> They give cash but take a cut >> Pay taxes on gains >> Coinbase will give money in your bank >> Then it comes to you -- > Fees, Taxes and Waiting
  • With Stable Coin >> Trade 1 Ethereum for 1000 USDC (If Ethereum = $1000)

How do Stablecoins work?

1. Collateralization

  • Fiat Collat.. each coin is backed by something mostly 1 USD
  • Much stable than the alternative
  • Disadvantage: Can be stolen

2. Algortithmic Mechanisms : Smart Contracts

  • Very easy to audit
  • No physical assets to steal
  • 3 Types of Algorithms:

i. Rebase (>$1) and Debase (<$1) : Changes the amount of coin in your wallet each time you check it so that value stays the same (Depending on the value of the coin)

Next 2 use human behaviour to stay pegged to USD

ii. Basis Cash: Money printer (>$1) and a bond reward system (<$1) to adjust price to $1

iii. Empty Set Dollar: Coupons (<$1) at a discount

  • Problems:

i. Too much focus on stability, with no sustainable use case for interoperability

ii. Current oracles are centralized and there is no decentralized ecosystem to reward them