What is DeFi?

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An Introduction to DeFi and Why it Matters

DeFi has grown exponentially since 2017 (Source: DeFi Pulse)

DeFi = Better Banking

If you’ve ever paid an overdraft fee, wire transfer fee, account maintenance fee, dealt with minimum balances or account freezes, you know that traditional banking could be better. A lot better.

DeFi is exactly that. Easier to use, better interest rates, no stupid fees, no trusting your money to a third party, no restrictions on what you can or can’t do with your money. Decentralized Finance apps aren’t just more decentralized than regular financial services — they’re better.

What’s Taken so long?

But wait, it’s 2019 and Bitcoin has been around for 10 years. Didn’t we have “decentralized finance” before? Wasn’t Bitcoin already supposed to let you “Be your own bank”??

Say hello to Bart. While Bitcoin is a great decentralized store of value over the long term, it’s a terrible savings account in the short term. It’s simply too volatile.

Bitcoin also has very little functionality by itself. You can hold on to it — while hoping it doesn’t go down — and you can spend it, but you can’t really do much else with it.

Ok then how about Ethereum? It’s a powerful smart contract platform that’s great for creating Decentralized Applications.

But it’s even more volatile than Bitcoin! Anyone who bought Ethereum in the last two years knows that its price is anything from stable.

DAI — The Building Block of DeFi

A decentralized Stablecoin from MakerDAO called DAI has been the essential building block which has allowed DeFi to exist and prosper. It solves the biggest problem of cryptocurrency-based financial service — Volatility.

While other stablecoins like Tether exist, DAI was the first decentralized stablecoin on a programmatic blockchain platform — Ethereum. Backed 150% by Ether and pegged to the US Dollar, its existence and backing is completely decentralized and native to the Ethereum blockchain.

Most importantly, DAI has stayed remarkably stable throughout 2018. Even when the ETH backing DAI went from over $1200 to under $100 USD — a drop of over 92%, DAI stayed right around $1 USD. With rock-solid stability and decentralized design, DAI acts as the fundamental building block of the DeFi economy running on Ethereum.

High Interest Savings — DeFi’s First Killer App

While DAI’s stability is pretty incredible, stablecoins are not very exciting by themselves. Compound Finance was DeFi’s first killer app. It achieved major traction by using the stability of DAI to create an awesome new use case — high-interest savings accounts.

Compound Finance is a decentralized lending platform that uses pooled liquidity instead of using direct loans. This seemingly small change makes a huge difference as it allows Compound to act as a high-interest savings account when lending DAI.

Whereas regular lending platforms, such as Bitfinex, require lenders and borrowers to negotiate the terms of each loan, lenders on Compound just need to lend their money to the platform and they automatically get interest payments, and vice versa for borrowers.

Interest rates on DAI have ranged from today’s 4% to as high as 15% in the summer of 2019. Compared to saving money in a regular bank account, saving money on Compound is much more profitable.

Compound has generated an incredible amount of interest. It’s been so popular, in fact, that other Dapps have started to integrate it.

DeFi Composability

Perhaps the most powerful aspect of DeFi isn’t just the cool applications being built, but the way these applications are easily integrated together.

Just as Compound has used DAI to build a cool new use case, other projects are now using Compound to enhance the functionality of their own applications.

rDAI allows you to save your DAI, and generate interest, and then point that interest wherever you want. You can give that interest to yourself, to a charity, or a friend — it’s completely up to you.

Rather than having to program all this functionality themselves, the designers of rDAI were able to leverage DAI and Compound Finance as building blocks to create a powerful new app, without having to recreate DAI and Compound Finance themselves.

PoolTogether is another example of these “money legos” working together to create new applications.

Using Compound on the back-end, Pooltogether is a no-loss lottery. You put your money in the pool to buy tickets in each week’s lottery. At the end of the week, if you win, you get the interest earned that week from the whole pool. If you lose — you retain your tickets — nothing is lost.

Better Finance

DeFi stands for Decentralized Finance, but that’s just part of the story. When we look at the alternatives in traditional finance, it’s clear that DeFi isn’t just more decentralized, it’s categorically better than anything else out there today.

Whereas Tether is a stablecoin controlled by a centralized entity without accountability or transparency, DAI is completely transparent, with every transaction and every ETH backing it visible on the blockchain.

Whereas your bank account generates next to no interest, Compound Finance gives you 4% interest, while giving you the freedom to withdraw any time, as much as you want.

Whereas trading cryptocurrency on Binance requires creating an account, depositing funds, placing orders and paying withdrawal fees, UniSwap lets you place orders with minimal fees straight from your wallet.

This isn’t just decentralized finance, this is categorically better finance.

Learn More About DeFi

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What is DeFi? was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.