Ok, this space is vast and expanding at the ‘rate of thought’, having recently picked up a few books on this topic I can see some major disrupting use cases emerging. Up to now the real magic around crypto has been the ability for trust-less decentralised transactions to be injected into a public ledger (brilliant) now with the most recent surge in interest in crypto we move to the next phase where positive yield, from previously idol assets, is now able to be generated by programmatically injecting transactions into the public ledger from some trigger event. This part is going to eat the world. Having read about this, the best way to sum all of this up would be the introduction of ‘programmable money/value’. Once you can program money/value you can eliminate the people in the middle of it, the bankers and lower costs significantly. Paving the way to a bankless world.
The number of applications in this space is as vast as the imagination required to develop interesting smart contracts and the immutable source code behind them. I have tried to sum up a few of these use cases to help those on the outside unpack this, it may eve help the reader understand why its way more than ‘money on the internet’.
Before I start to unpack some of the use-cases we need to dig into the idea of decentralisation. The best to way to sum this up would be the ability to for users to interact with providers of DeFi applications/contracts in a way that does not need the permission of an organisation to do so, its location agnostic, people agnostic where the application provides access to the code that performs the function that the application says it does. Anyone can access this from anywhere, just like the internet. I am going to explain DeFi, for now, with two very simple apps.
App1 – Decentralised Lending a Borrowing
The most vanilla and most classic approach to traditional finance – in this instance a smart contract is written to have lenders and borrowers. Lenders load/stake their liquidity to a smart contract in Eth and the smart contract handles the interest payments. Borrowers load some collateral to the smart contract and then receive Eth equal to a proportion of their collateral which is then required to be paid back at some future date. Some important notes: Borrowers must load more collateral than they are borrowing, lenders must keep their liquidity in the contract to enjoy the benefits of the positive yield. Classic finance all handled through total automation. (no links provided)
App2 – Decentralised Exchanges.
A DEX is an exchange that lives on the blockchain that allows users who send Eth to it to exchange this for another coin. This eliminates the centralisation risk that comes from using a traditional centralised exchange (how many we have we see blow up recently?). The simple way to explain this use case is users access a web app that houses the liquidity of one token and smart contract that moves those tokens around to the users that interact with it. The liquidity is held on the blockchain and recorded so effectively its acting as a provider of the tokens being exchanged, as if they are already there. Rather mathamagical.
In conclusion and in my defence, I have only just started looking into this space and the different use-cases it would be safe to say at this point that anything we currently do with money can eventually be done with a smart contract. The next 5 years (its 2021) will see major changes to the levels of disruption from DeFi will bring to traditional finance.
I will most certainly try to add more applications as I find the time to read about them, somethings are lotteries, savings apps and voting mechanisms. Really some very intriguing applications.
I have also been taking a load of tutorials to understand how a decentralised bank would operate and it seems that there are some very smart applications of DeFi that can ben used in the banking world. The relates to the opportunity of creating yield from the holding of particular cryptocurrencies. The basic premise of a bank is to take deposits, pay interest and also lend to borrowers then charge interest. This is the fundamental system of how a bank operates and this balancing act is performed by people/the bank in the middle of this process with huge amounts of effort and controls. Smart contracts now offer an opportunity to sit in the middle of this equation instead of the people. The Tutorials that I have worked have showed me the possibilities – they look like this.
A REACT application is created that is simply the interface between the user and the smart contracts. i.e. the functions of the bank that a customer can use. Behind this sits a range of contracts that when a button is pushed/product purchased the contracts functions kick into gear.
Saving: In the case of a depositor the user deposits their ether to into the bank (smart contract address) the smart contract then awards that depositors address with a new token which is considered the interest payment. This is all done at a rate and a term that the customer chooses they sits within the smart contract.
So deposit ETH earn a token.
Borrowing: When a bank customer wants to borrow money from the pool of assets of the bank, they request a their amount and post collateral equal to or more than the loan amount (to keep over collateralised), the smart contract then charges the customer interest with an expectation that the collateral decreases in value to a minimum level to avoid any default possibility. ALL of this is managed by a smart contract. The REACT framework is simply the front end with contracts that sit behind each button.