DeFi is short for “decentralized finance,” a way of doing financial business using peer-to-peer networks, blockchains, and other emerging technologies to eliminate middlemen and centralized control. In the traditional financial system, banks and various third parties, such as credit card companies, facilitate virtually every step in the movement of money from one person to another.
DeFi aims to allow these transfers to happen in a secure way, but without the verification, costs, privacy issues, and occasional delays associated with these third parties.
DeFi has become the focus of attention among cryptocurrency enthusiasts as the Ethereum network and its powerful smart contract capabilities have evolved. DeFi proponents use various systems to lend, borrow, and trade cryptocurrencies. These include individual tokens, including stablecoins, as well as exchanges, networks, and decentralized applications.
One of the reasons why Ethereum and smart contracts were crucial to the development of DeFi is because of the protocols. DeFi protocols are simply the codes, procedures, and rules that govern the systems used in DeFi. With the help of DeFi protocols, ecosystem participants can trade, borrow, stake tokens, and much more. These protocols should be available to all wallets so that everyone participating in the DeFi system can follow the same set of rules.
In general, DeFi protocols are self-contained applications encoded in smart contracts on Ethereum or a similar blockchain ecosystem. Most protocols attempt to define and improve one or more traditional financial processes. As an example, the DeFi protocol can aggregate data from various decentralized crypto exchanges in an attempt to consolidate trading and liquidity pools to make transactions easier for users.
It is clear that many DeFi protocols use very complex procedures to simplify and increase accessibility. When comparing different protocols, one metric that can be useful is the Total Value Blocked (TVL). TVL stands for the total underlying supply of tokens that is protected by a particular program. The largest DeFi protocol by TVL as of mid-2022 is MakerDAO, with a TVL of over $7.5 billion as of June of that year. This protocol allows users to borrow and lend crypto tokens. Users lock their own crypto assets in exchange for stablecoin tokens called DAI. Members can borrow and borrow, while the MakerDAO protocol uses smart contracts to liquidate loans and sell the collateral to maintain DAI stability.
The amazing thing about DeFi protocols is how broad they are. There are protocols that allow users to move assets from one blockchain network to another, exchange different pegged assets, create their own liquidity pools, take and offer loans, and much more. DeFi protocols even allow users to put money into alternative savings accounts or make riskier, more complex investments such as derivatives.
Some of the most popular DeFi protocols
Besides MakerDAO, some of the other most famous and popular DeFi protocols include:
- AAVE: AAVE is a lending protocol that has its own token, also called AAVE.
- UniSwap: UniSwap is a decentralized exchange operating in the DeFi space. Users can earn their own UNI tokens by offering liquidity.
- Curve: Curve is a liquidity aggregator that pools assets with the same peg, such as stablecoins.
- 0x Protocol: 0x allows users to move assets from Ethereum to Polygon, where fees are generally lower.
- Compound: Compound provides lending and borrowing opportunities that exist outside of the centralized financial system. It is a decentralized marketplace that allows users to block crypto assets to participate in the loan market.
- DeFi, or decentralized finance, aims to shift traditional financial systems to peer-to-peer networks to eliminate third-party control.
- Key to DeFi is an ever-growing set of protocols that are the rules that govern individual systems for DeFi participants.
- Total Value Blocked (TVL) is a key metric used to measure the performance and size of various DeFi protocols.
- As of mid-2022, the largest DeFi protocol was MakerDAO with a TVL of over $7.5 billion.
- DeFi protocols allow users to borrow and lend, save money in alternative savings accounts, invest in derivatives, and more.