DeFi: What it is, dApps, DEXs and Top 10 DeFi Exchanges in '24

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One idea behind blockchain technology is decentralization and making applications run without having the need for central bodies. In the traditional world, central bodies control various operations. To name a few, digital films and series are under the control of big studios or platforms like Netflix, or FMCG is controlled by few companies. Finance suffers from the same problem as it depends hugely on central bodies such as banks, governments, and other financial institutions. The operations that are controlled by central bodies in the traditional world are P2P in the crypto world and controlled mostly by dApps (digital applications or programs that exist and run on a blockchain or P2P network of computers). DeFi platforms utilize dApps to serve decentralized finance solutions.

What is DeFi?

“De” stands for “Decentralized” and “Fi” stands for “Finance”, put together, “DeFi” is “Decentralized Finance”. Decentralized means without having a need for intermediary central bodies such as brokerages, banks, or exchanges. DeFi utilizes smart contracts on blockchains instead of traditional financial instruments offered by central bodies.

How big is the DeFi market?

By October 2020, more than $11 billion (in cryptocurrency) had been deposited in various decentralized finance protocols, representing a tenfold increase over the course of the year. Approximately $20.5 billion had been invested in DeFi as of January 2021.

What are the most popular types of DeFi applications?

• Decentralized exchanges (DEXs): DEXs allow users to swap one currency for another, such as USD for BTC or Ether (ETH) for Tether (USDT). DEXs are a popular sort of exchange that links users directly, so they can trade cryptocurrencies without entrusting their funds to an intermediary.
• Stablecoins: A cryptocurrency that is linked to a non-cryptocurrency asset (USD, EUR, GBP, etc.) in order to keep its price stable.
• Lending platforms: Smart contracts are employed by these platforms to eliminate the need for middlemen such as banks to manage lending.
• “Wrapped” bitcoins (WBTC): A method of transferring bitcoin to the Ethereum network so that it can be utilized in Ethereum’s DeFi mechanism directly. WBTCs allow users to earn interest on bitcoin they lend out through the above-mentioned decentralized lending networks.
• Prediction Markets: Where people can gamble on the result of future events, such as election results, prices of various assets, sports results, etc. The purpose of DeFi versions of prediction markets is to provide the same functionality as traditional prediction markets, but without the need for intermediaries.

DeFi Glossary

As DeFi apps started to become popular, some new terminology was added to the crypto dictionary. Some of them are:

• Pools: Liquidity pools are pools of tokens that are locked within a smart contract and allow investors to receive a return on their holdings while facilitating efficient asset trading. Simply put:
  • You acquire Liquidity Provider Tokens (LP tokens), which indicate your stake (%) in a pool, once you submit an equivalent value of each token to that pool. When you add funds to the pool, these LP tokens are generated for you, and when you remove funds, they are burned, so the quantity of LP tokens you hold always corresponds to your stake/percentage owned of the overall pool. The only danger here is sudden loss. However, you do receive your share of the transaction fees.
  • As of January 2021, there was $250 million in the USDC-ETH pool. Other popular pools include WBTC-ETH, DAI-ETH and ETH-USDT.
• Farming: Some DeFi apps like PancakeSwap have “farms”, where traders can pair cryptos and stake them in “farms” as pairs to receive “harvest” periodically. Farming entails taking the LP tokens and placing them on a “farm.” Staking on a “farm” is same as executing a smart contract that allows the “farm” to keep your LP tokens. You usually get rewards in the form of another token that is striving to build popularity in exchange for the “farm” containing your LP tokens.
  • Yield farming: For experienced traders prepared to take a chance, yield farming is a method of sifting through numerous DeFi tokens in search of higher-returning prospects.
  • Liquidity Farming: When DeFi programs recruit users to their network by giving them free tokens, this is known as liquidity mining. This has been the most popular method of yield farming so far.
• Composability: DeFi apps are open source, which means that anyone may look at the code underlying them. As a result, using the code as building blocks, these apps can be used to “assemble” new apps.

What are DeFi Exchanges?

DeFi exchange is a specific type of DeFi platform/application. People can use DeFi exchanges to lend or borrow money from others, trade cryptocurrencies, insure themselves against risks, and earn income in savings accounts. A layered architecture and highly composable building components are used in DeFi. High interest rates are promoted by several DeFi programs. However, they often come with high risks.

How to Use a DeFi Exchange?

DeFi exchanges usually do not offer custodial wallets. Instead, users connect to these platforms through a Web3 enabled browser extension or application such as MetaMask, Binance Chain Wallet, Coinbase Wallet, etc. After you connect to the platform with your wallet, you can start exchanging cryptos immediately through easy-to-use, plain user interfaces provided by most DeFi exchanges.

What are the benefits of using DeFi exchanges?

• Simple and easy-to-use interfaces of DeFi platforms allow users to lend or borrow money from others, trade cryptocurrencies and use liquidity pools without hassle.
• KYC processes often take time and effort, but there is no need for KYC while using a DeFi platform for crypto exchange as wallet integration is done via non-custodial wallet integrations such as MetaMask and Coinbase Wallet.
• Forcing users to use non-custodial wallets, DeFi platforms enable secure crypto trading.
• High speed and low cost of transactions. Using DeFi platforms for exchanging crypto removes the need of having to wait on bank transfers or pay bank fees.

What are the downsides of using DeFi exchanges?

• Coding mistakes and hacks are common and as blockchain transactions are irreversible, a faulty DeFi transaction or deployment of smart-contract code with faults cannot always be easily reversed. Yam Finance, a business that launched in 2020, swiftly raised its deposits to $750 million before crashing due to a technical issue a few days later.
• The smart contract code that enables DeFi platforms is typically open-source software that can be easily duplicated to set up competing platforms, causing instabilities as funds transfer from platform to platform.
• Although the idea behind is to decentralize finance there is always this risk that the person or entity behind a DeFi protocol may be unknown, and may disappear with investors’ money.
• Due to the expertise required to interact with DeFi platforms and the lack of an intermediary with a customer-support department, inexperienced investors are at a higher risk of losing money.

Top 10 DeFi Exchanges

We shortlisted the top 10 cryptoexchanges in another article. Here is our shortlisted Top 10 DeFi exchanges list:

(*) Source: CoinmarketCap
(**) Source: CoinGecko
Note that all figures on the table were compiled on 30/09/2021

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This article was originally written by former AIMultiple industry analyst Izgi Arda Ozsubasi and reviewed by Cem Dilmegani