Last week we had a great introduction to Decentralized finance. For this week, we are going further, by exploring and understanding the various DeFi terminologies coupled with the major Components/building blocks of the DeFi ecosystem.
This is an acronym that stands for Decentralized Autonomous Organization. It basically implies a peer to peer network system/entity ensuring Self-governance/control of an asset. In one of the DeFi protocols “MakerDAO,” those who hold MKR tokens govern the Maker protocol for instance in ensuring the stability of Dai.
This is one of the core aspects of DeFi that simply means “freely accessible”. Any user with an internet connection anywhere in the world has full access to the DeFi ecosystem.
The DeFi ecosystem is open-sourced. It can be audited/customized by anyone anywhere in the world.
This implies the ability to build other protocols on top of the exciting protocols/ecosystem. The DeFi ecosystem is Composable. Developers have been able to build various DeFi products on the existing ones.
These are simply coded/programmed set of rules of procedure that automatically execute transactions when certain predesigned parameters are met. In DeFi, users interact with smart contracts without any 3rd party rather than the buyer, seller and 3rd party (middle man) model of traditional financial systems.
Automated Market maker
In DeFi, Digital assets are traded through leveraging liquidity pools rather than the traditional buyer and Seller trade exchange interactions. Users provide liquidity to what is known as a “liquidity pool”. Traders access those assets in the liquidity pool through borrowing and are automatically charged with a certain interest. Users that provide liquidity are also paid for providing liquidity to the exchange’s liquidity pool. This term is commonly used in DeFi trading protocols such as Uniswap DEX.
This simply means an asset’s ability to be converted into another asset.
This is an acronym that is abbreviated as Decentralized Exchange. DeFi has Decentralized exchanges such as Uniswap where trading of assets takes place through the interaction with smart contracts without a 3rd party.
This term refers to assets that derive their value from the real-world assets. This term is commonly used in the Synthetix DeFi protocol where synthetic assets replicate the prices of the real-world assets and users can trade those synthetic assets as though they were trading the real-world assets such as stocks, gold etc.
This is a term given to a certain class of Cryptocurrencies whose price value is fixed regardless of the price changes of the different crypto assets in the Crypto market. Stable coins are pegged to fiat currencies like EUR, Dollar, some are pegged to Cryptocurrencies, others to assets like Gold and this is done to ensure their price stability. For example, DAI is a stable coin used in the DeFi ecosystem. It is pegged to $USD.
Interested in learning more DeFi terms? checkout the DeFi encyclopia
Components of Decentralized Finance – Building blocks for DeFi
The millage of the DeFi ecosystem is heavily dependent on the following building blocks;
Decentralized Infrastructure – Ethereum
Unlike Bitcoin, the Ethereum Blockchain is a unique blockchain because of its programmability. It has a computation logic termed as ‘Smart contracts’ that developers leverage in building various protocols on top of it. For DeFi to succeed it needed a decentralized infrastructure that eliminates the 3rd parties from the financial interactions. The Ethereum architecture is therefore an ideal infrastructure for the building of the DeFi ecosystem because of its 3 core aspects including Decentralization, smart contracts and the open-source peer to peer network system.
Stable Coin – DAI
For a new financial system "DeFi" to thrive it needed a stable coin. The Crypto world is highly volatile. Prices of different crypto assets keep changing from time to time. They can dip sharply or pump highly. The building and running of a DeFi ecosystem was next to impossible due to such a highly volatile Crypto market condition. DAI is a stable coin used in the DeFi ecosystem. Its value is pegged to the Us Dollar. DAI’s price is maintained by Maker(MKR), a governing utility token in the DeFi ecosystem.
Decentralized Financial services, DEX, payments
Another Building block for DeFi covers financial services, Decentralized exchanges, payment DeFi protocols etc.
There are various financial services in the DeFi ecosystem including Compound which is a DeFi protocol facilitating the borrowing and lending process in the DeFi ecosystem. When a user deposits money in Compound ecosystem, he is rewarded with COMP tokens. Those who are borrowing money are charged with interest. There are other various lending services on DeFi and they include Aave, bZx, DeFiner, Reflexer, Swap rate etc.
In finance, trading is one of the core aspects. Therefore, the building of the DeFi ecosystem needed a Decentralized exchange where traders can exchange tokens by leveraging smart contracts without the need for a 3rd party. In traditional centralized financial systems, the buyer, seller and the 3rd party have to trust each other in all their trading deals but with a decentralized exchange, smart contracts are trustless. In other words, there is now no need for people to trust each other in DEX trading exchanges.
It’s now just a matter of initiating a sell or buy trade and the transaction is automatically and instantly executed by the smart contract system. There are various Decentralized exchanges for DeFi including Uniswap, Airswap, Tokenlon etc.
DeFi has various decentralized payment protocols offering quick and secure payments for example Flexa, a payment platform that is enabling merchants to accept digital currencies securely without any risk of Fraud and volatility caused through off-chain collateralization. Fuse is another payment DeFi protocol that is ensuring business integration in Blockchain.
For a more detailed list of the Various DeFi protocols, visit the DeFi Pulse
Homework task: Getting involved in the DeFi ecosystem requires one to have a DeFi web3 wallet; one must even know how to use it. The following is a list of some of the DeFi wallets; Select one and explain how to use it.
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