What is DeFi? If you’ve been hearing about this thing which is transforming the world of finance, but want an introduction to DeFi in simple language, then this article is for you!
DeFi (short for Decentralised Finance) is an emerging technology which promises to revolutionise financial products and services, making them more accessible, transparent and encouraging innovation.
DeFi platforms use decentralised blockchains, the technology which makes cryptocurrencies possible, to effectively remove the monopolies which large institutions, such as banks and brokerage firms, have had over the financial industry in the past.
Although DeFi is very new, it is one of the biggest growth industries in the world right now, and there is no sign of DeFi slowing down.
How does DeFi differ from traditional financial products?
In the past, if you wanted to take out a loan for example, you needed to go to a bank, or similar institution, which would generally take it’s time reviewing whether it thought you were a good risk or not, and which would base its offer on information such as your income, expenditure, credit history and other factors.
In other words, getting access to traditional forms of finance usually meant jumping through hoops and undergoing onerous, intrusive and opaque application processes with no guarantee of success.
So what is DeFi doing to challenge the banks and traditional institutions exactly? Well, Decentralised Finance is different in that it completely removes the banking institution completely from the equation. In this new world of DeFi anyone can access a wide range of financial services as long as they meet certain criteria, usually the ability to collateralise the loan.
There are no application forms, credit checks or long periods waiting for approval, and you don’t have to deal with a bank (which, let’s be real, do have a bit of a history of some seriously unethical behaviour).
Examples of DeFi products and services
The DeFi world is taking on the traditional financial services sector, and a wide range of services are currently available, including loans, insurance, identity verification, trading, prediction markets, gambling, futures and derivatives, and many more besides.
Some of the most popular and well known DeFi platforms include:
- MakerDAO: the first major DeFi project, MakerDAO is a decentralised loan platform with its own stablecoin, DAI.
- Uniswap: Uniswap is a decentralised exchange allowing anyone to swap tokens.
- Aave: A groundbreaking decentralised lending and borrowing platform, Aave pioneered the ‘flash loan’.
- Nexus Mutual: Nexus Mutual provides crypto and DeFi insurance against a range of risk events.
- Harvest Finance: Harvest Finance is an asset management and Yield farming protocol.
And of course, the greatest DeFi protocol of them all… Bumper, the unique price protection protocol, which we call “God Mode for Crypto”.
dApps
Most people are used to using various different online platforms and applications, but the majority of these are centralised, in other words controlled by a single company. They set the rules, and have the power to decide whether you can use their services, with little or no right to reply.
Furthermore, you tend to have to trust them to take care of your funds, as well as also being required to provide some identification to use their services, normally government issued ID and proof of residence (which excludes around 2 Billion people in the world!)
DeFi changes all that. The software applications built in this world are generally classed as dApps (Decentralised Applications) and are accessible to everyone, with funds and transactions managed by secure smart contracts, making the applications ‘trustless’… All you need to do is connect your wallet and off you go.
Market size and growth of DeFi protocols
The DeFi market in such a short space of time has grown at an incredible rate, demonstrating the desire that the market has for decentralised financial services.
Since the first DeFi protocols emerged around 2016, it has grown exponentially, reaching over $170 Billion market cap towards the end of 2021, just 5 years later.
Just to put that into perspective, that’s bigger than the annual number of payments made by credit cards.
Anyone who says DeFi is a passing fad or is ‘niche’ doesn’t know what they’re talking about. It’s only been around for a few years and has absolutely exploded.
Liquidity
DeFi protocols replace banks and traditional financial services providers, and this brings us onto the question of where they find the liquidity if they don’t have the bank’s reserves, or the ability to create new money out of thin air (which banks are allowed to do… did you know that?).
DeFi generally incentivises users with spare capital to provide the liquidity (the funds) to make their services available. This is made possible by rewarding these liquidity providers with premiums which are collected typically from the fees which are charged to the people who use the platform’s services.
This is called yield, and pretty much all DeFi protocols encourage crypto holders to provide liquidity of some kind, whether it be in the form of crypto or stablecoins, in exchange for the chance to earn yield.
When you provide liquidity into a DeFi protocol, you typically lock your crypto into their smart contracts, and in return receive Liquidity Provider tokens (LP for short), which represent your position. When you decide to exit and cash out, you return your LP token(s) and get back your deposits, plus any yield earned.
This is one of the keys to making money passively on your crypto holdings. A whole new industry has emerged allowing ordinary people to earn yields through providing liquidity.
Benefits of DeFi
DeFi usage hasn’t blown up for no reason. Those using the varying different protocols do so because there is money to be made in DeFi… Lots of money, and especially so for those who are early to the space.
Here are some of key benefits of DeFi over traditional finance:
- Permissionless and inclusive. All you need is a crypto wallet and an internet connection, and you can access the wide range of DeFi services available. You do not need to ask permission or become accredited to use DeFi products.
- Super fast. If you’ve ever tried to send money to a foreign country, you will know how slow it is to use the traditional banking system. In the DeFi world, transactions are normally completed in under a few minutes, sometimes in seconds.
- Transparency and Auditability. DeFi transactions are viewable by anyone on block explorers, which are free software tools which show you every historical and real-time transaction that takes place on the blockchain.
- Non-custodial. If you use a DeFi application, you can keep control of your funds in your own wallet, and don’t have to rely on a third party to manage your crypto.
- Secure. Due to the nature of blockchain technology, DeFi transactions cannot be tampered with by third parties.
- Open Source. A large number of DeFi protocols are open source, which means developers can replicate and build new innovative new products on top of existing ones.
Risks of DeFi
Of course, as with all great inventions, DeFi does come with some risks too, and it’s important to understand these risks before you plunge headlong into the world of DeFi:
- Lack of regulation. The DeFi space doesn’t have a regulatory body, and there is little or no consumer protection which you may enjoy in the traditional world. When the Terra protocol collapsed in May 2022, many users suddenly discovered their holdings were worth virtually nothing.
- Early and Immature technology. DeFi is still very new, and in fact the massive growth of DeFi protocols only really started around 2020. Because of this, glitches and hacks are still a threat, and there have been some pretty major thefts, mostly due to poorly written smart contracts.
- Impermanent Loss. Sometimes, market conditions turn against you, and it’s possible for you to end up with less in dollar value terms than you started with (even if you are collecting yields). Impermanent loss is where you are in that situation, but haven’t yet closed your position. It turns into a permanent loss when you do finally exit the protocol and cash out. Of course, the market could rally again, turning your impermanent loss back into profit, but you should be aware of this, because it’s probably one of the biggest risks in the DeFi world.
- Key Safety. It’s absolutely vital that you keep your private keys safe, and inaccessible to anyone else. This requires a bit of personal organisation, but there are plenty of ways to keep your crypto safe. We recommend the best way to ensure your safety is to invest in a high quality hardware wallet.
- High collateral requirements. Most DeFi lending platforms require you to collateralise your loans way above 100% of the value, and if the market crashes, you do run the risk of liquidation. This is one of the issues which Bumper’s protected assets can solve, and you can find out more about that here.
As with all financial decisions, you should do your own research, and it is always recommended to consult a financial advisor.
Bumper’s Unique Price Protection Protocol
The Bumper DeFi protocol is one of the most radical and game-changing protocols, which aims to solve one of the biggest challenges in crypto: Volatility.
With Bumper, you can protect your assets from sudden price drops, creating a safety net (we call it the floor) below which your crypto’s price won’t drop further. What’s more, if the price begins to rise again, you don’t miss out on the pump.
Bumper’s unique design attracts both Takers (those who want to protect their crypto from price drops) and Makers (those who provide liquidity in return for yield) in a fully automated, decentralised and provably-fair system which is governed by its community.
Conclusion
There are so many reasons why DeFi is the future of finance. It is taking away the centralised and monopolistic power which the financial institutions have enjoyed for since time immemorial, and allowing ordinary people to choose to participate on both sides of a truly inclusive financial services industry.
To learn more about Bumper, the price protection protocol, visit the Bumper website or if you would like a brief overview, check out this summary.
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