Decentralization disrupting the finance ecosystem

Most comprehensive guide to the decentralized finance ecosystem

It has become a trend for almost every crypto start-up proponent to tout their business fundamentals leveraging the decentralization values of blockchain technology.

But, is every crypto project based on a decentralization principle?

In this article, we’ll decipher how Decentralised-Finance protocol based businesses are different from the traditional ones:

We’ll be mainly covering two main aspects

1) What’s De-Fi in its true sense?

2) What are the kinds of De-Fi platforms and their major differences?

The Ultimate Guide to De-Fi Protocols

Users of the traditional financial system often wish for a system that is more accessible and transparent, charges low transaction fees, and is less reliant on intermediaries. For such a fairer financial system to emerge, banking, lending, and derivatives have to undergo a radical transformation. Also, the adoption of a decentralized ecosystem such as DeFi needs to happen. It facilitates peer-to-peer borrowing and lending, eliminating centralized control, and providing financial freedom to the users.

Lately, in the crypto realm, there is much talk about decentralized finance, or DeFi for short. It offers global access to financial services: loans, derivatives, and other products; and has reduced or no role for conventional financial intermediaries. Proponents of the decentralized financial systems are seeing DeFi, also called open finance, as a great alternative to traditional lending. Some are already calling it the future of lending and borrowing.

DeFi is built on public blockchains such as Bitcoin network and Ethereum. It has become one of the “core drivers of usage” on the Ethereum network. By leveraging the permissionless, distributed networks, DeFi platforms transform the financial products into trustless protocols, which can be accessed by anyone from any part of the world. People who have no accounts in banks can also use DeFi solutions for lending and borrowing assets, as well as for trading with financial instruments.

The open-source platforms offer their users great benefits, including transparency, cheap cross-border transactions, no credit checks, and reduced censorship. Anyone can execute financial activities as there is no geographical location restriction.

How Decentralized is DeFi?

In recent months, there has been a surge in the introduction of DeFi solutions. All of them do not offer similar features and advantages. They have different models, and their degree of decentralization varies as well. Some DeFi models are less decentralized compared to others. It is because only a couple of their components have been decentralized, while the rest are still centrally controlled by the company.

Development of protocol, non-custody, price feeds, determining the interest rate, provision of margin call liquidity, and initiation of margin calls are the key components of a DeFi protocol. They determine the degree of effective decentralization.

A DeFi protocol is more decentralized than other models if the number of decentralized components is greater. Such a protocol would give users complete control over their digital assets, getting rid of centralized controls. Until now, no DeFi protocol has decentralized all the components. Each DeFi protocol is assigned a category that is based on the number of decentralized components.

Centralized Finance (CeFi): DeFi solutions are typically non-custodial, which means the users have control over their funds and are responsible for their security. CeFi, on the other hand, is custodial. A centralized system has the custody of the users’ assets, and it is also responsible for ensuring the security of their funds.

Users have no control over any aspect of the funds when it comes to lending or borrowing them. Interest rates are determined centrally, as well as the liquidity for margin calls is offered by a central system or authority. CeFi products use centralized price feeds, and initiation of margin calls is not permissionless. Celsius and SALT are considered CeFi solutions.

Degree 1-DeFi: This category DeFi product is non-custodial, and that is all it has to offer on the decentralization front. Its other components are very much centralized, just like the CeFi solution. Users cannot determine the interest rate, manage the development or updates of the platform, or offer liquidity for margin calls. The product uses decentralized price feed; centrally initiate margin calls. Dharma is one of the best examples of degree 1 DeFi. It is a peer-to-peer marketplace on Ethereum.

Degree 2-DeFi: The DeFi solutions in this category are non-custodial, and offer minimal financial freedom to their users as only one more component is decentralized. The decentralized component can be platform development or updates; price feeds, initiation of margin calls, provision of margin call liquidity, or interest rate determination. Except for non-custodial and one more component, the rest of the degree 2 DeFi protocol’s components remain centrally controlled. Nuo Network is an example of degree 2 DeFi.

Degree 3-DeFi: This category DeFi solutions feature two decentralized components, along with the non-custodial factor. Compound and MakerDao are examples of degree 3 DeFi protocols. They have permissionless initiation of margin calls as well as permissionless provision of margin call liquidity. Users have no control over interest rates or development of platform; both are centrally controlled in this category DeFi protocols. Price feeds are managed centrally as well.

Degree 4-DeFi: In products under this DeFi category, interest rates and development of platforms and updates are controlled centrally. However, unlike the degree 3 DeFi solutions, price feeds are out of central control. Protocols such as Fulcrum and dYdX use decentralized price feeds. Also, they feature non-custodial component, and permissionless initiation of marginal calls and provision of margin call liquidity.

Degree 5-DeFi: The degree 5 DeFi products offer users almost complete control over their digital assets. Only the platform development component is centrally managed. Example of degree 5 DeFi protocol is bZx, the first decentralized margin lending protocol on the Ethereum mainnet. This category product is non-custodial, with decentralized price feeds. Participants determine interest rates. Also, the initiation of margin calls and the provision of margin call liquidity are permissionless.

DeFi Platforms Advantages against Centralized Platforms and Centralized Banking System

Users of centralized platforms can’t transfer borrowed funds to other trading venues and platforms. DeFi platforms offer this benefit to users. They are free to borrow capital and transfer it to multiple venues.

Unlike centralized platforms, DeFi platforms offer users full custody of digital assets. If they want to enter margin trading, which is buying and selling of securities in a single session, they can do so. Users can keep the tokens as well as short an asset on a decentralized network.

They cannot do so if they are using centralized platforms, where the funds are managed centrally, and not everyone can take part in margin trading due to restrictions and jurisdictions.

DeFi platforms eliminate the need for KYC.

Unlike a centralized banking system, the interest rates on DeFi’s P2P lending/borrowing platforms are determined by market forces and not regulators.

The information about the loans can be easily accessed by the participants and that too at no cost or a nominal cost.

The DeFi platforms are more transparent and efficient than traditional banking platforms.

Users can easily borrow funds at market rates, and the transaction process is very fast, as there are no intermediaries involved to facilitate the lending process.

Not everyone can access banking systems, but everyone who has an internet connection can access DeFi platforms.

How to Use a DeFi Platform?

Crypto Lending/Borrowing is one of the hottest trends in cryptocurrency innovation right now, with many companies jumping on the bandwagon while figuring out the novel ways to make a place for themselves in this unconventional infrastructure of financial lending products by integrating blockchain technology.

Let’s take a deep dive to analyze the industry leaders in this domain!

Compound vs Nuo vs Dharma vs Nexo vs Maker

Key considerations to analyze these platforms are the viability of the product, market fit, rates/collateralization, degree of decentralization, liquidity, funding & traction, and biggest value proposition.