While I intend to cover DeFi in depth in this post, I want to spare some lines to my favorite hobby i.e. bashing centralized banking system. In the past we have always used centralized finance which is where there’s a central authority that controls the flow of money. It is usually the government and the banks who are at the heart of this system. They can print as much of it as they want to. (A) They can stop you from borrowing it. (B) If they don’t want you to they can even stop you from having a bank account. (C) Since it is a purely trust based system, they could literally do anything with your money because you gave it to them. While these scenarios may look like unlikely, but history shows that governments have screwed up time and again.

Now you may think what alternative do we have right? Well, thanks to smart contracts and blockchain, now you do. Enter Decentralized Finance or DeFi. The hottest domain of cryptocurrency is here to rescue you.

What is Decentralized Finance a.k.a DeFi?

There are three main pillars on which DeFi is based on.

A. Cryptography

B. Blockchain

C. Smart Contracts

Top Use Cases of DeFi:

A. Stable Coin:

But why Stable Coins?

Say you own Ethereum worth Rs. 2000 from an exchange. Your analysis says that Ethereum is going to dip. If you plan to sell your holdings in return of USD/INR, it may be subject to taxes and a lot of fees (exchange, banks etc.). Not to forget that it may take some time for your money to reflect in your account. as there are multiple parties involved here.

While a lot of us may take banking services for granted, but if you have to transfer an amount greater than X, then bank has to be informed about that transaction. Don’t forget the exorbitant fees that would follow.

On the other side, crypto like USDT can enable a transaction of millions of dollars within a few seconds for as low as $5 in fees.

B. Lending and Borrowing:

The answer lies in overcollateralization and smart contracts. For borrowing fiat money worth Rs. 1000 you may have to put Rs. 1200 worth of cryptocurrency as collateral. One may ask why would I borrow if I already have the money? Well, say you hold BTC worth Rs. 1000 and you strongly believe that it is going to jump higher in the coming days. In such a case, you would not sell your holdings and instead borrow money using that crypto. You can use that money to trade elsewhere and make some money, only to come back and repay your loan.

But How?

Comes along another person who needs a loan of 10,000. He can put another crypto as a collateral (>10,000 worth) into that smart contract and now if he tries to run away with that money, smart contract will automatically liquidate his holdings and pay you back.

Flash Loan:

Flash loan is another interesting use case of crypto borrow and lending. It is a loan worth of millions of dollars given to you for about 10 odd seconds.

If you could buy Ethereum for $10 on CoinDCX and then sell it for $11 on Binance, theoretically you can make a dollar every time you did that and so you can use what we call is a flash loan to literally borrow millions of dollars. You don’t have to put any money down you just write a flash loan to borrow 10 million dollars and tell it to go buy Ethereum for ten dollars and then immediately sell it for 11. Ten seconds later you pay back the original loan. This way, you made a million dollars minus the fees that you had to pay for borrowing. These fees are small because the lender knew that you would have to pay them back and that it was for a very short period of time. Performing such an arbitrage is impossible in traditional finance.

C. Decentralized Exchanges:

If you have travelled abroad, you would know the pain of converting INR into USD or Euro. The rates of conversion are as high as 10% in some areas and you end up losing a lot of value of your money because of that. These exchanges are centralized and are managed by governments.

D. Insurance:

Let’s zoom out and think. What is insurance at a fundamental level? Nothing but a series of ifs and buts right? If X event occurs, pay Y amount to the beneficiary. Insurance companies use algorithms and ML models to evaluate the past history of a driver and come up with a fixed cost of insurance called premium.

But how does a smart contract measure rainfall? Well, its using something called oracles which connect real world to the cryptoverse. This definitely deserves another blogpost. For now, let’s assume it is absolutely possible.

E. Margin Trading:

Before diving into how DeFi turbocharges the margin trading, for the uninitiated, let’s cover what are we talking about.

Say you want to buy a stock of Reliance which is trading at Rs. 1000 right now. For buying this stock, you need a loan of Rs. 1000. You put a down payment of Rs. 200 and borrow this money to buy a stock.

Scenario 1:

Scenario 2:

This time around say the stock starts falling. From a Rs. 1000, price starts falling to a level of 900, 850 and 800. At this point, bank asks you to sell the stock and pay back your entire debt. You finally end up losing your down payment of Rs. 200 and the loan fee.

One thing is established here for sure. Margin is a really powerful tool to jumpstart.

And just like every other domain, Defi margin is much better than traditional systems. Let’s find out how:

Conclusion:

Each one of these five use cases of Decentralized finance or DeFi deserve a blogpost of their own. This field is so vast and revolutionary that it is all set to overtake CeFi with a storm. I am super excited to see the developments here.

What about you?

Got questions? Want to take it to the next level? Reach out to me using your preferred platform from the links below

Until next time..

For our beloved “non readers”, I also do quick carousels on these topics over Instagram. Come join the fun. Hit me up here.

This blog post is part of the blog challenge ‘Blogaberry Dazzle’ hosted by Cindy D’Silva and Noor Anand Chawla in collaboration with VoxBox and Journery Matters.