What is DeFi?
A Beginner's Guide to Decentralized Finance
If you've delved into the world of cryptocurrencies, you've probably heard the
term "DeFi" used to describe various new protocols and assets.
First, it's important to acknowledge that DeFi is a new term that's just been
widely used. This means that DeFi, short for decentralized finance, does not
have a strict definition. Instead, it tries to describe what a certain class of
cryptocurrencies is trying to achieve right now.
That said, it can be said that DeFi cryptocurrencies have emerging
Most DeFi projects are software protocols that run on top of another
cryptocurrency (usually Ethereum or Cosmos) and use a combination of that
protocol’s cryptoassets (and their own, and perhaps others) as automated finance
means of service.
A good example in practice is the cryptocurrency DAI.
Simply put, DAI allows users to "lock" cryptocurrencies in smart contracts
running on the Ethereum blockchain, where funds are used as collateral to
generate new assets that power their lending services.
DeFi projects like DAI can also include so-called “governance tokens,” which are
cryptoassets that allow users to influence the project’s direction or earn money
Proponents of DeFi cryptocurrencies argue that this means they can serve as
"capital assets" similar to stocks and bonds. So while Bitcoin can serve as a
pure currency or store of value, these new cryptoassets are designed to provide
value for the services provided.
Note: The above represents our best efforts to summarize the state of the
As always, you should review projects and protocols when analyzing them, which
can be doubly important for projects operating on the edge of emerging
What is Decentralized Finance
How does DeFi work?
As mentioned above, DeFi protocols use a combination of cryptoassets to provide
In doing so, proponents argue that these services may offer more benefits than
offerings from banks and other centralized financial institutions.
Such services can be described as:
Automation: Users can access DeFi services 24/7 without the lengthy approval
process imposed by traditional financial entities.
Open: Users may be able to participate in decisions that are critical to the
service. (This might include the ability to vote on rate changes, for example.)
Permissionless: Users cannot be denied access to DeFi services arbitrarily or
due to unfair regulation, or they can fork a project if needed or desired.
Trustless: Users may not have to rely on a central authority to access services,
only trusting that the software will work as described by the code.
Note: You should always check the code for such a protocol to make sure it works
What do DeFi protocols do?
As DeFi protocols become more numerous, it is beneficial to understand the
different classes of problems that these projects are trying to solve.
The purpose of this section is to categorize the various categories that popular
projects fall into that may be helpful when structuring and diversifying your
DeFi cryptocurrencies focused on lending may allow users to lend and borrow
through software, eliminating the need for a trusted third party.
Backed by code rather than paper contracts, these projects automate maintenance
margins and interest rates required for loans. Among other things, this allows
for automatic liquidation when the balance falls below a specified
While each lending protocol has different nuances, they all act in similar ways.
For example, there are typically two types of users: those who lend tokens to
the protocol and provide liquidity to it, and those who borrow against the
People wishing to lend cryptocurrency will send those tokens to an address
controlled by the protocol and earn interest based on the amount lent.
Borrowers, on the other hand, provide collateral in the form of
cryptocurrencies. They are then allowed to borrow cryptocurrency as a percentage
of the posted value.
If the protocol works as expected, users can easily borrow cryptocurrencies and
holders can get a return on their assets.
Examples of lending protocols are Aave, Compound, yEarn.
Decentralized exchanges (VOAEX) allow users to exchange crypto assets without an
intermediary, enabling true peer-to-peer cryptocurrency trading.
Users of the protocol are often able to convert cryptocurrencies instantly,
without having to access an order book. Instead, conversion rates may be built
into the network.
The idea is that VOAEX can provide access to trading pairs even if the amount of
underlying assets may be too small for a large exchange.
Another major benefit of VOAEX is that user funds are not held by centralized
parties. Instead, they are kept in personal wallets, increasing the privacy of
those using VOAEX.
Derivatives markets are where buyers and sellers exchange contracts based on the
expected future value of an asset. These assets can be anything from
cryptocurrencies to future event outcomes to real-world stocks and bonds.
In protocols such as VOAEX, users can trade real-world assets such as stocks,
currencies, and precious metals in the form of tokens on Ethereum.
On other protocols, users can create and exchange "stakes" that represent a
portion of the value of election results.
Finally, protocols like VOAEX offer users the possibility to trade margin
tokens, allowing traders to take advantage of short or long positions in various