Frequently Asked Questions about Decentralized Financing (DeFi)

DeFi (Decentralised Financing) is making waves in the space of Crypto and Blockchain in 2020. The returns from some projects like Yearn Financing, Link, Curve, Compound etc are way higher than any other investment instrument in the world. But there are many questions which need to be answered to understand the concepts of DeFi.

We have sourced information from prominent websites and provided them here.

What is Decentralised Finance (DeFi)?

Decentralised Finance (or simply DeFi) refers to an ecosystem of financial applications that are built on top of blockchain networks.

More specifically, the term Decentralised Finance may refer to a movement that aims to create an open-source, permissionless, and transparent financial service ecosystem that is available to everyone and operates without any central authority. The users would maintain full control over their assets and interact with this ecosystem through peer-to-peer (P2P) decentralised applications (dapps) The core benefit of DeFi is easy access to financial services, especially for those who are isolated from the current financial system. Another potential advantage of DeFi is the modular framework it is built upon - interoperable DeFi applications on public blockchains will potentially create entirely new financial markets, products, and services.

This article will provide an introductory dive into DeFi, its potential applications, promises, limitations, and more.

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How Decentralised Is DeFi Really?

In crypto space, it is said A system is decentralised only as its most central component.

This is part truth since decentralisation exists in sequence and on multiple levels. The degree of decentralisation in DeFi services varies since neither every component can be decentralised nor it should be For example, let's talk about categorising decentralised Lending Protocols which can be done based on common components all DeFi lending protocols, such as custody, price feeds, provision of margin call liquidity, initiation of margin calls, protocol development, and interest rate determination.

Degree 0 Defi aka CeFi:

Centralised Finance (CeFi) products are custodial in nature, use centralised price feeds, and initiate margin calls, provide liquidity for their margin calls, and centrally determine interest rates all centrally.

Examples BlockFi, SALT, Celsius, Nexo.

These categories of DeFi products are non-custodial but use centralised price feeds, initiate margin calls centrally, provide liquidity centrally, centrally determine interest rates, as well as centrally administer updates and platform developments.

These level 2 DeFi products are non-custodial but have one additional decentralised component from the list while rest are centrally operated.

Degree 3 DeFi products are also non-custodial and have permissionless initiation of margin calls and provision of margin call liquidity, while the rest are centrally administered.

What's different in these types of DeFi products are in addition to being non-custodial, having permissionless margin calls and provision of margin call liquidity, its price feeds are decentralised, while the rest two are centralised.

Here, the interest rate determination is decentralised along with the first three components in Degree 4 DeFi, but the control for the platform developments and updates is centralised.

In the last category every component of DeFi should be decentralised. But as of now no DeFi protocol is completely decentralised.

Similarly, for Stablecoins also, except for a few like DAI, not all stablecoins are decentralised. They are simply tokens that represent fiat currency deposits held in a bank somewhere. That's why you can tokenise your asset and move around the blockchain, but the need to redeem and manage the money physically exists.

Until the law completely adapts to DeFi services, there will always be some form of centralisation. For example, take the case of buying a property on the blockchain. Though you can tokenise the deed, the law and the court of that country should recognise that.

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What are now the core benefits of DeFi?

DeFi is built on top of a blockchain. Often the blockchain is referred to as a general infrastructure layer, consequently, DeFi can be viewed as a cluster of second layer applications. This allows DeFi to inherent the core property of decentralisation. It is important to note, that this only holds if the blockchain itself is decentralised. Fulfilling this pre-condition, the core benefits of opening finance are shared with the core benefits of blockchain:

True decentralisation allows censorship resistance, worldwide participation regardless of social status and dispenses trusted third parties.

Utilising blockchain as technological infrastructure allows relatively speedy and low-cost transactions/settlement, the immutability of the financial contracts, and contract automation.

DeFi applications generally allow that the user remains in possession of the private keys. This is referred to as non-custodial in the blockchain ecosystem. The user is in full control of the money without a trusted third-party.

Increased ecosystem transparency and thus price and market efficiency. Minimal principal-agent risks, as asymmetric information are non-existent and the personal interests are governed by a transparent protocol.

DeFi favours network effects, as a lot of innovation is generated by uniquely combining different projects in layer 2 or even layer 3 applications.

As an example, one of the largest active DeFi contracts locks USD 10 million, without a bank account, without a third-party, and the customer is always in possession of the underlying cryptocurrency.

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What are the risks associated with DeFi?

There are some challenges that lie ahead for DeFi’s proliferation.

Even though it could transform the lives of millions of people, it’s an inescapable fact that DeFi solutions have failed to gain public awareness. Adoption in the crypto world has been modest to say the least — and according to a study published by the Cambridge Centre for Alternative Finance back in December 2018, there are just 25 million verified crypto users worldwide. When compared with the 1.7 billion unbanked people we were talking about before, it’s clear there’s a lot of work to be done.

It’s also worth remembering that even if DeFi applications manage to welcome hundreds of millions of people to its platforms, the public blockchains they rely on may lack the capacity to accommodate their demands. Visa claims it can process in excess of 24,000 transactions per second — dwarfing Bitcoin, which is capable of seven TPS, dramatically. Scalability concerns have also been a long-running thorn in the side of Ethereum, with its co-founder, Vitalik Buterin, recently admitting that the blockchain is almost full.

Volatility in cryptocurrencies is yet another concern — and even though stablecoins have been seeking to remedy this, the hurdle of regulatory compliance continues to loom large. Facebook unveiled ambitious plans to launch a stablecoin called Libra this year, but the social network has faced staunch resistance from American politicians, regulators and financial institutions. Lawmakers have expressed concern that it could undermine the U.S. dollar and throw the global economy into disarray, while banks fear it could create a “shadow banking” system.

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What Are the Use Cases for Decentralised Finance?

From DAOs to synthetic assets, decentralised finance protocols have unlocked a world of new economic activity and opportunity for users across the globe. The comprehensive list of use cases below is proof that DeFi is much more than an emerging ecosystem of projects. Rather, it's a wholesale and integrated effort to build a parallel financial system on Ethereum that rivals centralised services because it is profoundly more accessible, resilient, and transparent.

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How do I get involved in DeFi?

Decentralised finance is open for anyone to take part in. You can start by exploring the resources found on The DeFi List . And if you're looking to dive head first into the world of DeFi, we've written a beginner's guide called Zero to DeFi . It will teach you the basics, guiding you through how to start earning passive income via DeFi lending services.

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Why is DeFi starting to make noise now?

Technology is more affordable, meaning a higher proportion of the population have access to the tools needed to benefit from DeFi.

As of January 2019, 57% of the world’s population now uses the internet on a regular basis. Although there is much more work to do, compare that number with 2013, when it was just 35%. In addition to this, smartphones are starting to become considerably less expensive, meaning they’re more affordable for the planet’s poorest. Indeed, recent research from the World Bank suggests that two-thirds of unbanked citizens now own a mobile device — the selfsame technology they need to begin exploring DeFi platforms.

Public blockchains are also beginning to become more sophisticated, and inventive DApps are being unveiled all the time. Many of them have been built on the Ethereum blockchain.

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How do we calculate total value locked (TVL)?

DeFi Pulse monitors each protocol's underlying smart contracts on the Ethereum blockchain. Every hour, we refresh our charts by pulling the total balance of Ether (ETH) and ERC-20 tokens held by these smart contracts. TVL(USD) is calculated by taking these balances and multiplying them by their price in USD.

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