What is DeFi? Exploring the Operating of Decentralized Finance
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Introduction
The financial industry has been growing increasingly complex, with the perception that it must be secretive, expensive, and layered. However, DeFi (Decentralized Finance) has emerged as a disruptor, offering an open, affordable, user-friendly, and accessible financial system. It challenges the norms and presents new possibilities.
By learning about and embracing DeFi, we could contribute to making the world a little better.
Interestingly, when we discussed DeFi, we came across a range of technical terms that were unfamiliar to us before. Terms such as blockchain, smart contracts, or stablecoins have gained prominence in recent years and require some learning. On the other hand, some financial terms such as lending and collateral are familiar to us but are untouchable behind a veil.
New technological terminology and traditional finance concepts are intersecting, giving rise to a new set of terms that open up a complete financial landscape that is accessible and operable to everyone.
DeFi Overview： A Validated Financial System
In the face of the vast traditional financial landscape, DeFi continues to be a "movement" that requires a long process. However, in terms of DeFi itself, it is no longer just a "concept" or an "experiment". It has evolved into a well-defined, stable, and effective decentralized financial system. At its peak in late 2021, the total valuation of Defi exceeded 100 billion US dollars.
Bitcoin initially posed a challenge by introducing the concept of "cryptocurrency" above traditional currencies, offering a "blockchain ledger" and enabling "cryptographic payments". Building upon this foundation, Ethereum added "smart contract" functionality to the blockchain, making currencies more accessible and democratizing computational accounting. As a result, finance gradually shifted towards protocols supported by algorithms. With the development and iteration of companies like MakerDao, Uniswap, Aave, Compound, Yearn, dYdX, Curve, and Pando, Defi has now become a thriving and diverse financial ecosystem.
Through various algorithms and contracts in the DeFi field, individuals can engage in decentralized trading, asset collateralization, lending, yield farming, and other financial activities. People trust DeFi and it has rapidly grown as a complement to traditional finance due to the following advantages compared to traditional finance:
Decentralization：DeFi leverages blockchain technology to create a new system that operates without central institutions. It enables transactions to be conducted peer-to-peer, without relying on third parties. This shift empowers users with greater autonomy, control, and improved global liquidity.
Transparency：Through open-source protocols and the recording of transaction data on the blockchain, DeFi ensures transparency in transaction logic and processes. This public visibility reduces uncertainty, fosters trust, and enables the verification of DeFi protocols by all participants.
Efficiency: Operating solely on algorithms and protocols, DeFi utilizes smart contracts to execute transactions. This eliminates redundant processes found in complex traditional financial systems and reduces manual intervention, resulting in highly efficient financial transactions.
Accessibility: With reduced costs and lowered barriers to entry, DeFi becomes more accessible to individuals. This increased accessibility makes DeFi more user-friendly and available to a wider range of people.
Flexibility and Innovation: With transparent underlying data and lower entry barriers, coupled with smart contracts, DeFi enables programmable financial actions, fostering flexibility and diversity in transaction behaviors. DeFi greatly supports various innovative experiments, leading to a rich ecosystem of financial activities.
Today, Defi has emerged as a validated financial system, serving as a complement to traditional finance. Simultaneously, it holds immense potential as a challenger. As DeFi continues to grow and innovate, it presents an exciting opportunity to reshape the global financial landscape.
Building the Foundation of DeFi: Establishing the Technological Framework
The technology behind DeFi is evolving and there are numerous paths for its analysis and discussion. For example, we can use the term "blockchain", which provides a new way of constructing networks, or we can discuss DeFi using smart contract programming languages, or the algorithms behind Automated Market Makers (AMMs) are very important. These discussions have multiple dimensions that intersect with each other. For the average person, understanding DeFi may begin with the question "What is this technology used for?" This approach makes DeFi more accessible and easier to comprehend.
To understand how DeFi is structured and operates, we can explore it through six key terms:
1. Blockchain
Bitcoin and blockchain technology have provided us with a new monetary and ledger system. The emergence of BTC and the ability of Ethereum (ETH) to self-issue currencies through smart contracts lay the foundation for DeFi, as it revolves around cryptocurrencies.
2. Public Ledger
The transparency provided by public ledgers enables features like computational accounting and algorithmic participation in bookkeeping. The openness of transaction records allows for transparent financial analysis and auditing. Additionally, the immutability of the ledger establishes a foundation of trust.
3. Smart Contracts
ETH not only lowers the barriers to cryptocurrency issuance but also empowers transaction automation through programmable "if-then" capabilities. Smart contracts enable transactions to occur under specific conditions, reducing the need for intermediaries and minimizing human intervention. This opens up diverse possibilities for DeFi implementation.
4. dApp
Decentralized application (dApp) has entered the world of cryptocurrency. It can run autonomously on the blockchain and continuously enhance its functionality through programming based on smart contracts. This enables simple transaction behaviors to be combined into complex transaction logic, resulting in specific financial functionalities such as lending, borrowing, and savings.
5. Protocols
Even for the same transaction behavior, different transaction logic can be applied. These logics, the conditions, the constraints of the transactions, and the underlying algorithms are collectively referred to as "protocols". Protocols are defined as rules that have gained user consensus and are fixed through programming. Essentially, financial behaviors have transformed into transaction behaviors defined and supported by various protocols.
6. DAO
Decentralized autonomous organization (DAO) has rich implications. In Defi, DAO combines currency, voting, and decision-making behaviors. It is determined by algorithms and currencies, giving it special powers of equality and fairness. Dao respects value, follows the guidance of interests, and makes decisions and adjustments based on rules. This gives DeFi the ability to organize based on algorithms.
Building upon these technologies, numerous protocols and organizations have emerged. Taking MakerDao as an example, it allows users to issue a stablecoin called Dai using a collateral protocol and utilizes the MKR token to represent ownership for voting and decision-making within the DAO. The entire protocol runs on top of the Ethereum blockchain through smart contracts. It fully embodies how currency, ledger, smart contracts, dApps, protocols, and Dao support a DeFi application and enable various financial activities such as collateralization and stablecoins.
A new world is gradually being built upon these foundational technological frameworks.
DeFi Applications: Key Financial Practices in the DeFi Space
Starting from MakerDao's issuance of the stablecoin Dai based on collateralization, a wide range of financial activities have emerged in the Defi space through diverse smart contracts, programming, dApps, and protocols. This process has been vibrant and colorful, marked by significant advancements and occasional setbacks. Through trial and iteration, most traditional financial behaviors have found counterparts in the DeFi field, and some user-friendly and robust financial services have gradually become stable and sustainable, becoming part of people's daily lives.
Behind each type of financial activity lies important algorithmic progress and protocol development. However, from an application perspective, we are more interested in exploring which financial practices in DeFi are accessible to ordinary individuals in their daily lives.
1. Trading
People can use decentralized wallets to manage their cryptocurrencies. AMM algorithms encourage regular users to provide liquidity, enabling transactions to occur automatically based on decentralized trading protocols. These protocols define the rules and processes of transactions, allowing peer-to-peer transactions through smart contracts and eliminating the need for centralized exchanges. Well-known decentralized protocols include Uniswap, SushiSwap, and Curve. And, Pando Protocol is one of them.
2. Collateralization
Collateralization is a widely adopted financial application in DeFi, where existing crypto assets are used as collateral to obtain loans or other financial services. There are various forms of collateralization available in the market, allowing users to earn interest, and token rewards, and engage in liquidity mining and synthetic assets. However, the mainstream approach is to use collateralized assets to obtain stablecoins or other cryptocurrencies for investment and trading. For example, MakerDao enables users to collateralize BTC to generate the stablecoin Dai.
Similarly, in Pando DeFi, users can collateralize assets such as BTC and ETH to obtain the stablecoin pUSD.
3. Stablecoins
Stablecoins employ various mechanisms, including those backed by fiat currencies such as USDT and USDC, those backed by crypto assets like Dai and pUSD, and algorithmically regulated stablecoins. Stablecoins based on native cryptocurrencies like Dai and pUSD align more closely with the transaction logic of smart contracts, allowing users to obtain stablecoins based on collateral protocols.
Stablecoins like Dai and pUSD emphasize quick conversion between stablecoins and crypto assets. They serve as a medium of exchange within the trading ecosystem, mitigating the impact of significant price fluctuations in cryptocurrencies during transactions. Additionally, they enable transactions between digital and real-world economies.
4. Liquidity Provision
DeFi encourages users to provide liquidity for trading by participating in liquidity provisions. Through the Automated Market Maker (AMM) algorithm, users offer to buy and sell transaction pairs, and the algorithm and smart contracts facilitate trading and distribution fees. This lowers the barriers to entry, allowing users to profit from financial means.
On Pando, you can participate in existing trading pairs and create your liquidity pools.
Financial practices in DeFi are highly diverse. In addition to the mature, robust, and widely adopted applications mentioned above, contract assets, decentralized fund management, insurance markets, prediction markets, bond markets, and derivatives markets are all areas of exploration and development within the DeFi ecosystem.
DeFi Experience: Navigation for Beginners
Entering the world of blockchain can be more challenging for beginners than expected. You have to quickly familiarize yourself with numerous new terms, and applications, and, given the involvement of money, exercise caution and concerns. This difficulty is somewhat equivalent to someone who walks every day suddenly having to learn how to drive—a bit simpler, perhaps.
In the realm of finance, it is typically an enormous and mysterious metropolis that is generally beyond the reach of ordinary individuals. However, for someone who has learned to drive a vehicle, it suddenly becomes a place for joyrides, allowing you to easily observe the city's scenery and reach various destinations.
Therefore, this is something worth learning and exploring. We will provide a basic framework to serve as your guide for this journey.
First and foremost, it's about learning.
In the beginning, it may be necessary to understand BTC and blockchain and gain knowledge about ETH and DeFi. This will provide you with a basic orientation in the world of cryptocurrencies. Once you have grasped some of the terminologies and principles, you can search for tutorials on various common applications. Additionally, it's essential to familiarize yourself with common security pitfalls and be mentally prepared.
Next, let's start with the concept of "cryptographic assets."
You need to learn how to use fiat currency to purchase cryptocurrencies. However, the most important aspect is to understand the concept of wallets and manage the purchased cryptocurrencies within your wallet. Additionally, you should be able to transfer them and participate in exchanges. Consequently, you will learn about acquiring, transferring, converting, and safeguarding cryptocurrencies. Speaking of wallets, I would recommend learning about Metamask, Mixin, and Fennec.
Then, you can begin engaging in various financial experiences.
The previously mentioned practices such as collateralization, stablecoins, trading, and liquidity provision are the most fundamental financial practices, and they all have mature and representative applications. Each experience will require some learning curve, allowing you to gain a sense of price fluctuations and fluctuations in returns over a short period.
Pando DeFi integrates various financial applications. Here, you can not only try trading and provide liquidity for trades, but also participate in Pando Leaf for collateralization to obtain the stablecoin pUSD, and utilize Pando Rings to support lending and borrowing of cryptocurrencies. Through these features, you can complete the core DeFi experiences without incurring any gas fees.
Finally, you need to develop your investment and wealth management strategy.
Based on your understanding, you can gradually increase your cryptocurrency holdings, or you may choose to adopt a conservative stance toward this new world. Furthermore, you need to consider which cryptocurrencies you have more confidence in. Will you prefer holding a few tokens with strong consensus, or would you like to hold a variety of currencies to seek more opportunities? Lastly, you have to decide which financial applications to use and find your approach amidst the diverse choices of long-term investments and short-term trading.
The path of DeFi challenging traditional finance has just begun, and there is no need to rush. You must carefully consider the risks you can tolerate and whether you want to continue learning and expanding your knowledge to navigate the new world more effectively.
We will attempt to periodically update this article, providing content that is more consensus-driven and stable, rather than overly novel explorations.
The information contained in this article is for informational purposes only and does not constitute financial, investment, or other professional advice. The views expressed in this article are those of the author and do not necessarily represent the views of the company or organization they work for or Pando. Any investment decisions made by the reader should be made after consulting with their own financial advisor and conducting their own research. The author and the company or organization they work for and Pando will not be liable for any financial losses incurred as a result of reliance on the information contained in this article.