With Telegram’s second presale on the way, we figured it was time to do a deep-dive on new ways that blockchain and cryptocurrencies are fueling an explosion of “decentralized finance.”
Decentralization is one of those concepts we hear about often yet still struggle to grasp. The best definition we’ve seen comes from Naval Ravikant :
As with most things, the most interesting developments are happening on the fringes. That’s why we’re watching exciting experiments like MakerDAO and Compound, decentralized “banking” services which are each leveraging crypto to fundamentally change the way people interact with finance.
We think the trend of Decentralized Finance (DeFi) has legs; not only are people increasingly willing to trust code over institutions, but they’re using blockchain technologies to build financial primitives that have never been possible before. And conversely, these new financial primitives are best suited for decentralized systems.
This article is our deep dive on DeFi, why it’s important, and which platforms we’re watching most closely. If you are a beginner or an expert trader on the Bitcoin Trader app, this information will be quite helpful to you.
What is Decentralized Finance (DeFi)?
We’re using the term “DeFi” to describe an emerging trend of new applications built on top of decentralized financial primitives. We define decentralized finance as any system that does not require trust. By removing the need for trusted institutions, these systems are more resilient and they distribute risk—a stark contrast from centralized finance, which concentrates it.
What are decentralized financial primitives?
Decentralized finance runs on many types of decentralized financial primitives, each with their own best use cases. They can be broadly categorized into crypto-native primitives, cryptographically-backed tokens built on top of existing blockchains, and centralized precursors that are being replaced by their decentralized counterparts.
Crypto-Native Primitives
Crypto-native financial primitives enable censorship-resistant stores of value, mediums of exchange, and standard ways of managing custody over any asset.
Atomic Swaps
Most crypto-native financial primitives are made possible by “atomic swaps,” an exchange between two parties of one cryptocurrency for another without either party needing to trust each other or a third party. First theorized in 2013 by Tier Nolan , they’re most commonly used today to trade cryptocurrencies of the same chain.
Stablecoins
In order for a medium of exchange to be useful, it must have a stable value. This is especially important when that medium of exchange is intended to represent something else, like an asset or a coupon.
Centralized financial institutions create stability by pooling assets and issuing IOUs in return, but this comes with counterparty risk, as their bankruptcy can cause the value of those IOUs to drop.
Stablecoins avoid this problem by pegging their value 1:1 with fiat currencies or real-world assets like gold. The best examples are issued on top of existing blockchains— some are collateralized by other cryptos, while others are collateralized by cash reserves or real-world assets themselves.
Tether, which is collateralized 1:1 by the US dollar, has long been the market leader—its $2.8 billion market cap makes it the world’s 20th most valuable cryptocurrency. But Tether has recently come under fire for its lack of transparency and recent loss of banking partners.
Summing Up
At the forefront of decentralized finance are crypto-native primitives: cryptocurrencies that can be sent and received without a trusted third party, where the sender has full control over the funds being transferred.
This is what initially captured our interest, as it empowers people to take their own economic destinies into their own hands. Crypto-native primitives enable new applications on top of them, such as exchanges and lending platforms.