Decentralized finance, or DeFi for short, is the nickname of financial smart contracts, decentralized applications (DApps), and protocols built on Ethereum. Financial DApps are the hottest use case of Ethereum at the given moment.
One of the most unique parts of decentralized finance that the smart contracts are publicly accessible and highly interoperable. Similar to Lego, individual parts of DeFi can be pieced together to make something new. And so, decentralized finance excites many people because of how it empowers individuals and creates new opportunities like never before.
We built DeFi Pulse as a way for the community to follow trends in DeFi. Our DeFi Pulse leaderboard tracks the assets and their total value locked into the smart contracts that make up decentralized finance. Also, we compiled even more DeFi resources you can check out into The DeFi List.
Now, let’s break down each category of decentralized finance to shed some light onto this ecosystem.
One of the most popular use cases of DeFi is lending and borrowing tokens. Lending is an extremely popular way to earn passive income in DeFi. And while you may think lending to a stranger sounds risky, most loans made in DeFi are secured loans with more collateral than borrowed value. This reduces the risk for lenders.
MakerDAO is the most popular lending DApp that allows you to lock in ETH for a stablecoin called Dai, a token pegged to the USD. Dai provides a way for token holders to access liquidity at the cost of an annual interest rate. Dai plays a vital role in the DeFi community as the most popular stablecoin.
Decentralized exchanges, or DEXes for short, are smart contracts that allow users to buy, sell, or trade cryptocurrencies or tokens. Because they live on the Ethereum blockchain, these exchanges operate without a central authority. Instead, the smart contracts enforce the rules, execute trades, and securely handle funds when necessary. Unlike a centralized exchange, there’s often no need to deposit your funds before making your swap. Try trading on a DEX for yourself.
A derivative is a contract, the value of which is determined by the performance of an underlying asset. Similarly, Derivative markets in DeFi trade nearly any asset on the blockchain using synthetic pricing. For example, synthetic price feeds create derivative tokens for stocks, futures, and even Bitcoin using smart contracts. In a similar way, prediction markets are another popular type of derivative market in DeFi. Prediction markets essentially let users bet on the outcome of any event.
The payments category is largely dominated by layer 2 payment channel networks. These networks are built on-top of existing blockchains like Ethereum or Bitcoin, AKA layer 1. Payment networks allow two parties to create instant transfer payment channels. As you may know, blockchains are only able to handle so many transactions in a timely manner. And so, layer 2 solutions allow users to trade a bit of the security and decentralization of Layer 1 for the convenience of speed. Ultimately, these qualities make layer 2 payment channels ideal for smaller, frequent payments like those found in commerce.
Tokenized assets and asset management is a quickly growing sector of DeFi. Existing financial assets deployed to the blockchain as tokens fit nicely into DeFi protocols which extend their utility. Asset management protocols allow investors to put their money in the hands of smart contracts or fund managers which manage their portfolio. Other asset management protocols, such as Set Protocol, employ automated strategies such as periodic rebalancing or following technical indicators.