Users of the traditional financial system often want to build a system that is easier to access, more transparent, lower transaction costs, and less dependent on intermediaries. To build such a fairer financial system, banks, loans and derivatives must undergo fundamental changes. In addition, a decentralized ecosystem such as DeFi needs to be adopted. It facilitates p2p lending, eliminates centralized control, and provides users with financial freedom.
Recently, in the field of cryptocurrency, there has been a lot of discussion about DeFi. It provides financial services to the world: loans, derivatives and other products. Moreover, the role of traditional financial intermediaries has weakened or even failed to function. Proponents of the decentralized financial system believe that DeFi is a good alternative to traditional loans. Some people have called it the future of lending.
DeFi is built on public blockchains such as the Bitcoin network and Ethereum. It has become one of the "core drivers" on the Ethereum network. By using a permissionless distributed network, the DeFi platform converts financial products into trustless protocols, which can be accessed by anyone anywhere in the world. People who do not have an account in the bank can also use DeFi solutions to lend and borrow assets, as well as use financial instruments for transactions.
Open source platforms provide users with huge benefits, including transparency, cheap cross-border transactions, no credit checks, and reduced censorship. Anyone can conduct financial activities because there are no geographical restrictions.
Decentralization level of DeFi
In recent months, the introduction of DeFi solutions has surged. They have different models and their degree of decentralization is also different. Compared with other models, some DeFi models have poor dispersion. This is because they only have a few components that are decentralized, while the rest are still centrally controlled by the company.
The formulation of the agreement, non-custody, price supply, determination of interest rates, provision of margin call liquidity and the start of margin call are the key components of the DeFi agreement. They determine the degree of decentralization.
If the number of decentralized components is large, then the DeFi protocol is more decentralized than other models. Such an agreement will allow users to fully control their digital assets and get rid of centralized control. So far, there has not been a DeFi protocol that has scattered all components.
Each DeFi protocol is assigned a category based on the number of scattered components:
Centralized Finance (CeFi)
DeFi solutions are usually non-custodial, which means users can control their funds and are responsible for their safety. Instead, CeFi is managed. The central system keeps users’ assets and is responsible for ensuring the safety of users’ funds.
When it comes to loans or borrowing, users have no control over any aspect of the funds. The interest rate is determined by the central government, and the liquidity of the margin call is provided by the central system or authorities. CeFi products use a centralized price supply, and it is also permitted to initiate a margin call.
Level 1
This type of DeFi product is non-custodial, which is the only attribute it provides in terms of decentralization. Its other components are very concentrated, just like the CeFi solution. Users cannot determine interest rates, cannot manage the development or update of the platform, and cannot provide liquidity for margin call notifications. Products are supplied at a decentralized price, and margin calls are initiated centrally. Dharma is one of the best examples. It is a peer-to-peer market on Ethereum.
Level 2
This type of DeFi product is non-custodial. Since only one component is decentralized, it provides very little financial freedom for users. Decentralized components can be platform development or update, price supply, initiation of margin call, liquidity provision of margin call, or determination of interest rate. Except for unmanaged and another component, the remaining components of the DeFi protocol are still under centralized control. Nuo network is an example of this degree.
Level 3
This type of DeFi product has two discrete components, as well as non-custodial factors. Compound and MakerDao are examples of this degree. They can initiate margin call requirements without permission, or provide margin call liquidity without permission. Users have no control over interest rates and platform development, and price supply is also managed centrally.
Level 4
In this DeFi category of products, interest rates, platform development and updates are all centrally controlled. However, unlike the 3-stage DeFi solution, the price supply of such DeFi products is not under centralized control. Protocols such as Fulcrum and dYdX use decentralized price supply. In addition, they also have the characteristics of non-custodial, initiating margin calls without permission and providing margin call liquidity.
Level 5
Level 5 DeFi products provide users with almost complete control over their digital assets. Only platform development components are centrally managed. An example of a 5-level DeFi protocol is bZx, which is the first decentralized margin loan protocol on Ethernet. This type of product is non-custodial and has the characteristics of decentralized price supply and participants determining interest rates. In addition, the initiation of margin calls and the provision of margin call liquidity are not permitted.
Advantages of DeFi platform over central platform and central bank system
Centralized platform users cannot transfer borrowed funds to other trading venues and platforms. The DeFi platform provides users with this benefit. They can freely borrow funds and transfer them to multiple locations.
Unlike centralized platforms, DeFi platforms provide users with full custody of digital assets. If they want to enter margin trading, that is, to buy or sell within a trading day, they can do so. Users can keep tokens and short-term assets on a decentralized network.
If they are using a centralized platform, they cannot do this. On a centralized platform, funds are centrally managed, and due to restrictions and jurisdiction, not everyone can participate in margin trading.
The DeFi platform eliminates the need for KYC.
Unlike the central banking system, the interest rate of DeFi's P2P lending platform is determined by market forces, not by regulators.
Participants can easily obtain information about loans without any cost or nominal cost.
DeFi platforms are more transparent and efficient than traditional banking platforms.
Users can easily borrow funds at market interest rates, and the transaction process is very fast, because no intermediary is involved in facilitating the loan process.
Not everyone can access the banking system, but everyone with an Internet connection can access the DeFi platform.
in conclusion
DeFi is still in its infancy, but advocates of the decentralized financial system have declared that it has great potential. It is currently the most active part of the encryption field, and its growing popularity cannot just be ignored as a fashion. A recent market report noted that DeFi agreements have grown "astonishingly" in less than a year. The value locked in DeFi increased from US$181 million to more than US$500 million within a year.
The report also predicts that by the end of 2020, the total value locked in DeFi may exceed $1.5 billion. If DeFi agreements are widely accepted, they are very likely to reshape financial instruments.
But the question here is the bankers and the government will let this kind of systems. If they do, of course the first thing they will think is profit and taxes respectively.