The Ultimate Guide to Decentralized Finance (DeFi)

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what is defi

Introduction

Bitcoin met with much skepticism when it was introduced in 2009. Many believed that these digital tokens had no real purpose and that the hype surrounding them was purposeless. However, digital finance and digital currencies defied all these notions and came out to be a big technological revolution that is rechristening the entire banking scenario, one innovation at a time.

Cryptocurrency, smart contracts, Cefi, Defi, and Dapps are a few examples of innovations in the banking sector. Amongst them, DeFi and Defi applications have been seen gaining popularity and momentum recently. Defi aka Decentralised finance or decentralized banking leverages blockchain technology to create open banking systems that eliminate the need for middlemen or banks. It employs smart contracts which are then used in decentralized applications or Dapps. Decentralized finance applications are mostly built on Ethereum. Understanding its application and use cases is important for anyone looking to invest in them, but before that, let us understand Defi in detail

What is Defi (Decentralised Finance)?

DeFi applications are applications that employ secure distributed ledgers to provide financial services. Contrary to decentralized finance banking institutions like banks and brokerages, Defi applications empower its users to peer-to-peer digital transactions. They successfully eliminate the need for intermediaries saving their users from fees levied by banking institutions and have more control over them. Defi applications allow its users to hold, transfer, and trade funds, and assets to anyone with a stable internet connection. Any reliable dApp Development Company can help a business build a robust DeFi application with different use cases; given below are a few.

Use cases Decentralized finance(DeFi)

Smart Contracts

Smart contracts are simply programs stored on a blockchain that execute themselves when certain parameters are met. These actions revolve around releasing funds, registering a vehicle or property, and issuing tickets. A network of computers executes the actions when predetermined conditions are met. Ethereum programming languages like Solidify are elemental in developing smart contracts that are robust and secure.

Decentralized exchanges(DEXs)

Decentralized exchanges are platforms that help exchange currencies and cryptocurrencies or both. These platforms allow users to trade directly by executing smart contracts and keeping order books. Types of DEXs include automated market makers, Order books DEXs, and DEX aggregators

Stablecoins

Decentralized stablecoins are cryptocurrencies that are designed to act as real currency with a fixed stable value or fiat currency such as USD or INR. Stablecoins are extremely popular applications as they act as a fixed unit of exchange in transactions, purchases, trades, and investments.
Fiat-backed stablecoins, algorithmic stablecoins, and collateralized stablecoins are among the several stablecoin kinds seen in the DeFi ecosystem. The most well-known stablecoins are BUSD, DAI, USDT, and USDC.

Lending platforms

Platforms for decentralized lending offer loans to individuals or companies without the need for middlemen. Conversely, everyone may profit from interest on provided stablecoins and cryptocurrencies thanks to DeFi lending protocols. Examples of decentralized lending institutions are Abracadabra, Alchemix, Compound, and Benqui amongst others.

Prediction markets

In a decentralized prediction market, users can exchange contracts that pay out depending on how certain future events turn out. Prediction markets are, to put it simply, exchange-traded marketplaces designed for trading event outcomes. These markets, when run on DeFi principles, provide secure predictions and offer the same purpose but without middlemen.

Yield farming

Yield farming is another Defi application that is making waves in the tech and fintech markets. For experienced traders, users use Defi tokens and map their progress for larger returns. The process involves depositing these tokens into a liquidity pool to earn revenue. Yield farming has multiple ways to earn revenue but the most common currently happens to be putting cryptocurrencies into a trading pool.

How does DeFi work?

Defi works on certain protocols that allow its users to borrow cryptocurrencies or digital assets at an interest. Platforms like Ave, and Compound are examples of these protocols which lend money and then earn from the interest. Many decentralized exchanges(Like Uniswap) even let users trade Ethereum-based tokens and stocks whose value is determined by these protocols.

Main features of a Defi Platform

  • DeFi provides options to transfer assets at all times via a simple internet connection thus providing accessibility to all users.
  • DeFi platforms are known for their low transaction fees and high returns.
  • Defi platforms are the epitome of security and transparency. These features are extremely enforceable by smart contracts
  • Another characteristic feature of Defi is autonomy which means that it renders certain level of autonomy to its users

Defi- Risks and challenges

Vulnerable to threats

Like any other software, DeFi apps are susceptible to flaws and attacks. Vulnerabilities in DeFi apps are exploited by hackers to pilfer money or alter financial transactions. Exploits and hacks can degrade the reputation of DeFi apps and result in large financial losses.

Lack of regulations

Since Defi is a newer avenue, it still lacks strict regulatory compliances which deters users from using its platforms. Lacks of security regulations further leave DeFi platforms susceptible to cyber attacks and vulnerabilities.

Centralization

Although DeFi is decentralized, some Defi applications rely on centralized features such as liquidity pools. Such centralization in nodes opens up the network to vulnerabilities and threats.

User errors

Defi applications handle day-to-day high-value transactions, which often incurs errors on the user end such as incorrect password and misplaced addresses. This can turn costly when high-level transactions and trades are at stake.

Benefits of Defi Platforms

  • DeFi platforms are devoid of geographical limitations. That means that anyone across the globe can use Defi applications via a crypto wallet and a strong internet connection.
  • Faster transactions and simpler overall service accessibility are the result of the improved speed of blockchain technology coupled with the absence of middlemen and borders.
  • All Defi platforms provide increased transparency compared to conventional and centralized finance platforms and institutions.
  • Automation is another added benefit of DeFi platforms. Defi tokens, smart contracts, and other DeFi tools can help automate regular transactions and finance workflows.
  • Interoperability is another outcome of the system’s flexibility. Protocols and dApps, when combined, complement one another more easily than they do in the realm of conventional financial services and solutions.
  • Needless to say, immutability is a feature that decentralized systems deliver. Double encryption and data protection provide extra security to all transactions.

Steps to make a Defi application

Development of a DeFi application requires meticulous planning, a high technical skill set, and an in-depth study of the entire Defi ecosystem. Here are a few steps to keep in mind for businesses looking to embark on the development journey of DeFi applications.

  • Identify the use case of the DeFi App: It is important to identify the application objective of your Defi App. This can be decentralized lending, borrowing, yield farming, or other Defi applications.
  • Planning app architecture: This step entails the planning of all core features and functionalities that the intended applications will offer to its client. This can include wallet integration, smart contract development, and lending protocols, amongst other DeFi features.
  • Blockchain platform selection: The next important step is to select the right blockchain platform, Ethereum being the most common choice for the same. There are also other blockchain platforms available in the market. These are Smart Chain, Polkadot, Solana, etc.
  • Build Smart contracts: To automate your process and leave little to no manual inputs, building smart contracts is extremely crucial for any Defi application. One can do so by writing these contracts in Solidity, an Ethereum-based programming language if building on Ethereum.
  • Develop a stellar User Interface (UI): The next step entails building a user-friendly interface, one that enables users to operate the application seamlessly.
  • Integrate Wallets and APIs: Integrate popular cryptocurrency wallets that allows users to connect with your app and fetch real-time transaction data. Enterprises must also ensure stringent security in these wallets via different security mechanisms to protect customer data.
  • Test and Deploy: This is the final phase in which the application is tested for bugs and deployed henceforth for public use. It is also accompanied by post-launch maintenance and support. The application is also upgraded as per customer needs afterward.

Conclusion

Building a DeFi application is the new norm. With more and more enterprises looking to invest in Defi applications, one can foresee the DeFi industry going mainstream in tech markets soon. Once strict regulations are in place, Defi might be the safest alternative to modern-day banking, which is why businesses should hop onto this bandwagon of the latest blockchain technology trends and invest in blockchain development services at the earliest. OpenXcell is a reliable company to start with in DeFi app development. With a rich portfolio of successful blockchain projects and 700+ happy clients, it is a great company to trust a blockchain development project with.

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author
Samragyi Chamoli
AUTHOR

Zealous, enthusiastic, and consistent, Samragyi is an ardent reader and an experienced writer. She loves animals and adventure.

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