DeFi is a suite of projects all focused on providing permissionless financial services to anyone with an internet connection.
Interestingly enough, the vast majority of these projects are built on the Ethereum protocol, thanks to its robust developer network and widespread adoption in the blockchain industry at large.
Why should I care?
For anyone actively involved in the world of crypto assets, DeFi has provided a crucial layer of useful financial products. Seeing as the large majority of ETH traffic came from the rise of speculative investments in the form of ICOs, DeFi shifts the focus away from native ERC20 tokens (although some platforms do use native tokens) to novel features and use-cases unlocked by the advent of complex yet efficient smart contracts.
For those of you who have never heard of DeFi, ICOs or even Ethereum, this movement is one worth paying attention to. Investment potential aside, DeFi is challenging the notion of what a “bank” really is, encouraging individuals to become self-sovereign through a variety of web 3 wallets, all of which serve as a universal entry point to the larger Ethereum ecosystem.
With DeFi, your wallet becomes the access key to virtually every application.
Now, let’s assume this is the first you’ve heard of DeFi. We strongly recommend starting out with a bit of Ether ($ETH) stored in a web3 wallet like MetaMask.
Once the bases are covered (meaning ETH is in a MetaMask wallet), here are a few of the most commonly used products are services:
- Trade on Uniswap – Use a sector-leading DEX to see how easy it can be to swap between two Ethereum tokens.
- Open a Vault – Head on over to Oasis Borrow to open your very own Vault. By locking collateral such as ETH, users can take out a loan in DAI (a stablecoin) that can be paid off at any time.
- Lend on Compound – Got some assets sitting in a wallet collecting dust? Head on over to the Compound Finance app to earn interest by lending them to the DeFi ecosystem at large.
- Enter PoolTogether – Feeling lucky? Put some Dai into the PoolTogether pot for a chance to win a prize every week.
- Buy a TokenSet – Looking to take advantage of sophisticated trading strategies? Check out Set Protocol’s most recent TokenSets to take part in complex trades all by purchasing a single ERC20 token.
While this list could go on and on, the important thing to note here is that DeFi is largely accessible with a very small amount of capital. Virtually all DeFi transactions are instant, meaning there is no need to wait for a third party to get started.
Things to note
When it comes to examining new DeFi applications, there are a few key components to keep in mind:
Custody is used to describe who holds (or maintains custody) of your assets. Most services fall into two buckets: custodial or non-custodial.
Custodial solutions can be highlighted by exchanges such as Coinbase or Binance. This means that although there is an “account balance”, the totals seen on the asset overview are merely numbers on a screen, credited by the true owner, the exchange provider.
On the opposite side of the spectrum, we have non-custodial solutions – or services in which the provider does not maintain ownership over the assets passing through the platform. Non-custodial solutions like Uniswap or dYdX generally involve the usage of smart contracts, in which assets are locked and transferred using autonomous code rather than by human actors.
Most of the popular solutions the average individuals come across on their journey through the blockchain landscape starts with a custodial solution. As users become more advanced, non-custodial solutions unlock niche services that truly inherit the trustless nature that many blockchain solutions were built on.
There’s nothing *wrong* with custodial solutions, but please be sure to take note of who owns the assets in any given solution and as always, be sure to participate at your own risk.
Smart contract audits
With the large majority of DeFi applications being heavily reliant on complex smart contracts to function smoothly, audits are crucial. Smart contract audits consist of an unbiased third-party reviewing every line of code to identify bugs, vulnerabilities and bottlenecks.
Famously highlighted by the DAO hack of early 2016, unaudited smart contracts can lead to major setbacks, including the loss of funds, manipulation of the system or the permanent shutdown of a once viable company.
There are many companies built specifically for smart contract auditing. Some of the more well-known providers include OpenZepplin, Quantstamp and Blockgeeks.
While it is important to ensure that the quality of the team auditing a contract is reputable, it’s even more important to check if the smart contracts have been audited at all. Regardless of if a project has the most amazing sales pitch you’ve ever heard, without at least one audit report, it’s difficult to know (as an average user) if the system can be trusted.
When it comes to analyzing the DeFi ecosystem at large, we wanted to provide you with a few industry-standard tools to quickly research which projects are gaining the most traction.
- DeFi Pulse – A DeFi ranking platform that keeps track of which platforms have the most “locked value”, often signalling the most usage.
- DeFi Reddit – Includes an active stream of posts mainly centred around DeFi.
- DEX Tracker – An easy to use scanner to keep track of all the DeFi activity any given Ethereum wallet has accumulated.
- DeFi Prime – An awesome resource for all things DeFi, similar to ours!
DeFi red flags
When it comes to researching the next big dApp or platform, there are a few key components to keep an eye on and be extra careful if one or more conditions are met:
- If the rates are too good to be true, they probably are. Whether this is lending, staking or mining pools, there are general standards for what acceptable rates are. Be sure to use the tools listed below to cross-reference the rates of any given service
- Anonymous or lack of team. Despite the fact that DeFi is entirely built on the assumption of “decentralized” infrastructure, virtually all of the top platforms boast an extremely strong and seasoned team. If you’re viewing a project and can’t find any mention of the team or who’s working on it, this can likely be a flag that something nefarious might be happening behind the scenes
- GitHub Inactivity. One of the easiest ways to check if a team has been delivering on its promises is to view the project’s GitHub. Seeing as the large majority of DeFi project are open-sourced, this means that all changes and updates are made public from the moment they happen. If you stumble across a GitHub and notice that there hasn’t been any activity in months, it may be a sign that the project has been abandoned and that you should utilize the service with extra caution.
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With so many new DeFi applications being built each day, it can be hard to keep up! Rest assured that as it stands right now, the current ecosystem favors the sophisticated trader actively looking to leverage themselves through the use of margin trading or borrowing.
With this being said, there’s no doubt that multiple solutions are being designed specifically for everyday individuals to take advantage of services that have become more or less obsolete in the world of traditional finance today.
The clearest example would be that of a basic savings account. While most banks are offering a mere 1% or less for money that sits in savings, with DeFi, lending stablecoins (tokens with the exact same value as your USD) generally earn much higher interest with relatively small risk.
To summarize, it’s quite evident there are a number of unique use-cases making sure that DeFi is here to stay. As Ethereum continues to tackle its scaling challenges, be sure to keep a close eye on what’s being built on top.