Decentralized Finance (DeFi) Explained in 5 Minutes (Video)
DeFi, or Decentralized Finance, is a huge part of the crypto space. In this video, we explore its background, vision, mechanism, as well as advantages over traditional financial services.
You've already heard about DeFi, right? DeFi products and services have been growing over the last two years. OKChain currently is getting ahead of the DeFi trend and deploying its own DeFi ecosystem. Still, many people are wondering, "What is DeFi?" DeFi, short for decentralized finance, generally refers to digital assets and financial smart contracts, protocols, and decentralized applications, dApps, built on top of blockchain networks. Bitcoin, the peer-to-peer electronic cash payment system, is the first DeFi application put to use in the real world. The fairly new and automatic borrowing and lending protocol, MakerDAO, has been able to produce even more applications, making DeFi more popular and achieve greater adoption.
Unlike traditional lending and borrowing services, MakerDAO protocol allows its users to generate Dai by depositing collateral assets into Maker vaults within the Maker protocol. To protect against cryptocurrency volatility and support Dai's value, every Dai in circulation is directly backed by excess collateral, meaning that the value of the collateral is higher than the value of the Dai debt, which is also called the collateral-to-debt ratio. When Ethereum-based collaterals drop and push the collateral-to-debt ratio down below 150%, the Maker protocol will take the liquidated Maker vault collateral and subsequently sell it using an internal market-based auction mechanism.
The decentralized borrowing and lending dApps have opened a new chapter for DeFi space, and DeFi movement is shifting the traditional financial products and services to the blockchain sector. Decentralized finance is not only rebuilding traditional financial products and services, but it also builds a bridge between the traditional financial system and the crypto sector. Synthetic assets and oracles are connecting the financial space with crypto. Synthetic assets allow users to get other assets with one asset as collateral. For example, the stablecoin USDT is one of the synthetic assets, as one USDT will be issued only after $1 is deposited as collateral. In this way, we can map physical assets onto a blockchain.
Oracles help transfer data to a blockchain. While Oracles help transfer data to blockchain networks, many DeFi smart contracts need real-time data input, such as MakerDAO. It needs real-time Ethereum price data. In a word, Oracles enable DeFi to deliver financial services to its users in real time. After knowing about the above DeFi projects, many people will ask, "What are the advantages of DeFi applications over financial services?" Instead of counting on centralized financial systems, where you don't know how their internal processes work, blockchain technologies remove these trusted third parties and shifting these surfaces to unbiased, transparent, and highly efficient permissionless systems.
As a result, you can check the transactions by just checking the DeFi transaction ID on the blockchain and see that it's transparent and open source, available to anyone anywhere in the world. Compared to the traditional banking systems restricted by time and people, DeFi is rebuilding the financial services, which are automated, running 24/7, and accessible to anyone and anywhere. DeFi offers people a promise of enjoying the friction-free financial services between two parties without the hassle from central authorities or middlemen. Everyone is accessible to the benefits of DeFi applications. DeFi composability adds another dimension. Like LEGO bricks, developers can recompose these protocols to develop new products. All this has made it much easier to develop new DeFi applications, whose financial services are easily accessible to every person. So, with so many advantages that financial systems are lacking in, is DeFi a perfect option?
With DeFi applications blossoming, there are still some potential risks. While DeFi protocols bring the fundamental benefits of transparency, security, and efficiency to users, DeFi protocols with significant capital are also an attraction for people who want to try to exploit or attack it. More than 15 hacking incidents struck DeFi applications in the beginning of 2020 alone. As the surge in DeFi has increased the incentive for attackers to find exploits, some DeFi projects are already deploying more rigorous risk management systems, among other measures, to address these serious issues. DeFi ecosystems are also improving on all kinds of levels to counter these challenges. While the emergence of Bitcoin enabled a decentralized payment system after the 2008 financial crisis, DeFi is now rebuilding the entire financial system. Though DeFi is still in a nascent stage, it is constantly bringing the fundamental benefits of transparency, security, and efficiency to users, and is addressing issues existing in the traditional financial market. With DeFi ecosystem fastly expanding, we expect more innovations will come about in upcoming years. Come to OKX and check out more about DeFi.