In 2021, the DeFi sector has grown by 1210%, from $18.71 billion to $245.22 billion. DeFi projects can make money from their assets – lending, making deposits, trading ahead of the curve and so on.
Important: For this article, we took information from specialist publications. Whether or not to buy certain tokens is up to you to decide.
What is DeFi
DeFi is an independent financial ecosystem open to all users. In it, participants interact with each other directly, without intermediaries – banks, credit institutions and others. This way, transactions can be carried out faster and cheaper.
DeFi protocols are considered among the most secure and reliable because they are based on blockchain and smart contract technologies.
Blockchain is a distributed database in which information about completed transactions is stored as a continuous chain of blocks. The information within this system cannot be tampered with.
A smart contract is a computer algorithm that accurately executes a given agreement between two or more parties to a transaction.
Most DeFi protocols are powered by the Ethereum blockchain. Although activity is growing on other platforms, such as Polkadot or EOS.
Smart contracts execute on the blockchain the conditions laid down for the transaction and make a financial turnover within a given marketplace. The process is fully automated and gives the parties to the contract the assurance that the information recorded in the code is secure, encrypted and cannot be used by third parties for their own purposes.
Because of its reliability and practicality, DeFi has quickly become popular and is still in high demand. In November 2021, the size of the decentralized finance market reached $274 billion.
The list of current DeFi projects is regularly updated. Here are 10 popular DeFi tokens based on their market capitalization according to CoinMarketCap.
Current DeFi tokens. Source: coinmarketcap.comActual DeFi tokens. Source: coinmarketcap.com
Current DeFi tokens. Source: coinmarketcap.com
Terra is a project to create stabelcoins, which are cryptocurrencies that are usually (but not always) pegged to fiat currency at a 1:1 exchange rate. They can be issued by cryptocurrency exchanges and other cryptoprojects. Stablecoins combine the advantages of both fiat and cryptocurrency money – exchange rate stability and fast, accessible settlement.
Luna is Terra's own network token. It is used for stealing, that is, for passive earning, in which users store coins on the Proof of Stake (PoS) algorithm and ensure that the blockchain works. The tokens can also be used to manage and ensure the stability of the Stablecoin exchange rate.
Avalanche is one of the fastest blockchain-based smart contract platforms. It was launched by a team of US developers in September 2020. The system operates at a speed of around 4,500 transactions per second.
The goal of the project is to remove regulatory and geographical barriers to cryptocurrency transactions.
Avax is a native token of the Avalanche platform that users can receive by stealing.
Wrapped Bitcoin (WBTC)
Wrapped Bitcoin is a technology that transfers Bitcoin to the Ethereum blockchain. It is designed for users who work with Bitcoin but want to start using DeFi applications.
Chainlink is a decentralised network of oracles that work together in a network. Oracles are real data points that can connect to blockchain-based smart contracts.
Chainlink provides users with access to real data, events, payments and guarantees the high level of security that blockchain technology provides.
Link is an ERC-20 protocol token that is used for payment and ensures the accuracy of the Chainlink network.
Uniswap is a decentralized exchange based on Ethereum (DEX) that facilitates the exchange of ERC-20 tokens between merchants.
Uniswap (UNI) is an Ethereum token. It underpins the Uniswap protocol, which combines tokens into smart contracts and creates liquidity pools . Platform participants can exchange assets, create new trading pairs, add tokens to pools, and receive commissions for doing so.
DAI is a stabelcoin based on Ethereum. The Maker Protocol application and the decentralised autonomous organisation MakerDAO are responsible for the development of this project.
The price of a DAI Stablecoin is pegged to the US dollar and is secured by a set of other cryptocurrencies, which are stored in smart vault contracts each time a new DAI is issued.
Fantom is a high-performance, scalable and secure smart contracts platform. It can be used to overcome the limitations of previous generation blockchain platforms. Fantom is permission-free, decentralised and open source.
FTM is the token for the Fantom network, which enables network operation, payments and collections.
Tezos is a multifunctional decentralised blockchain platform designed to support the operation of smart contracts. Users can use it to create tokens and decentralised applications.
Tezos differs from other smart contract platforms in that it provides the ability to update the network without a hardforward split into two different blockchains.
Aave is one of the first DeFi platforms in the crypto market, bringing together lenders and borrowers in a decentralised space. It provides users with a peer-to-peer lending system.
AAVE token holders can lend their coins and receive passive income, while borrowers can borrow cryptocurrency at stable and variable interest rates.
PancakeSwap is a decentralised finance application that runs on the Binance Smart Chain (BSC) network of the BEP-20 standard. It allows users to exchange tokens and provide liquidity through revenue pharming and commission payments.
CAKE tokens are used by the exchange for exchanges, farming and so on.
Tokens with great growth potential
There are many different projects in the decentralised finance sector that offer the opportunity to make a profit for placing their assets. Paycer UG founder and CTO Niels Gregersen thinks: the DeFi sector will continue to grow in the coming years, and users will see many new products that they can't imagine today.
Brian Gross, network manager at crypto platform ICHI, believes: DeFi and DAO are likely to be the fastest growing areas in the crypto industry in 2022.
From the analysts' predictions, the DeFi market will continue to grow strongly. Here's a list of DeFi tokens with high growth potential in 2022, based on Yahoo.Finance forecasts.
Aave (Aave).A decentralised Aave platform was created in 2017 under the name ETHLend. It aims to bring lenders and borrowers together in a decentralised space so that they have an equal opportunity to lend assets at interest and be rewarded for deposits.
Avalanche (Avax).The project positions itself as the fastest blockchain-based smart contracts platform, which can process around 4,500 transactions per second. Avalanche recently received a $230 million investment for its DeFi initiatives.
Cardano (Ada).The multi-tiered blockchain platform Cardano has been positioned as an alternative to Ethereum since its launch. The platform's internal cryptocurrency is called ADA. The platform is all about running smart contracts, decentralised applications and multi-party computing. The advantages of Cardano include the robust security of Ouroboros, high transaction speeds and complete privacy.
Chainlink.This is a decentralised network of third-party data providers that work together in a network. They provide smart contracts with information from external sources that are not related to the blockchain. One of the goals of the Chainlink network is to decentralise smart contracts in order to increase the security and accuracy of the information.
Polkadot (Dot).This is a network that combines blockchains into a single space where they quickly and securely process and exchange information from different blockchains. Polkadot promises users a solution to the problem of scalability – low transaction speeds on the network and high fees. Polkadot has been called a major competitor to the Ethereum blockchain, which has scalability issues.
Terra (Luna).A next-generation smart contracts platform that issues its own Luna token. The Terra platform combines decentralised finance with the concept of stabelcoins. Users can make fast international payments at low fees.
Polygon (Matic).A protocol and framework that helps build and connect Ethereum-compliant blockchain networks. The goal of Polygon is to increase the ability of the Ethereum blockchain to handle more technical workload and make transaction fees cheaper. Polygon addresses some of Ethereum's limitations: low bandwidth, transaction delays, lack of community management, and so on.
Advantages and disadvantages of DeFi-applications
DeFi-applications, like any element of the financial system, have their advantages and disadvantages. Here are their main pros:
Decentralisation. Unlike the public financial system, DeFi has no centralized management structures. All the rules of business operations here are strictly prescribed in smart contracts. This minimises errors due to the human factor.
Open source. The source code of DeFi-applications is always available in the public domain. Any user can check its reliability, security and functionality. This is needed to rule out hidden malware while running in the background.
Transparency. Cryptocurrencies are attributed anonymity because blockchain accounts consist only of numerical addresses that make it impossible to tell who owns them. But this is not entirely true. All transactions in DeFi projects are accessible and you can always verify their owners if you want to.
Lack of bureaucracy. To work with DeFi-applications do not need to go through a lot of checks, transactions are carried out in a couple of clicks, and users can work with them from anywhere in the world where there is Internet. Due to this, international payments on DeFi-platforms are usually carried out faster than in banks.
Accessibility. Approximately 2 billion people worldwide lack access to financial services – opening a bank account, transferring money from one account to another, and so on. DeFi, on the other hand, makes it possible for everyone to access financial services easily and quickly.
Low costs. Transfers are made quickly and without a chain of intermediaries, which reduces fees.
Simplicity. DeFi has no supervisors or accounts that require you to fill out complicated forms.
And here are the disadvantages of DeFi applications:
There are no clear regulations. The European Commission adopted rules to regulate crypto-asset markets back in September 2020. However, they cannot affect the DeFi sector.
No one is responsible for you. Financial institutions are not responsible for the actions of customers within the DeFi system. If you lose your password or do something wrong – no one can help you.
Dramatic price fluctuations. Crypto-asset prices can rise or fall dramatically. When the price of an underlying asset locked in the CDP drops sharply, investors start withdrawing their assets and the system may crash. To mitigate these risks, DeFi-protocols try to provide credits with an excessive amount of assets.
The risk of smart contracts being hacked. A critical bug in the protocols can harm the entire system. In such a situation, hackers can infiltrate any network chain and steal customers' cryptocurrency.
Small amounts for loans. Loan amounts in the DeFi sector are smaller than in banks and other financial institutions.
Excessive hype and fraud. People can launch DeFi projects, actively promote them online, and after the trade gains momentum, they withdraw their clients' money and disappear.
How and where DeFi is used
Decentralised Stablecoins are cryptocurrencies that are backed by underlying assets, typically 1:1. For example, at the time of writing, 1 Tether = $1, 1 USD Coin = $0.9998.
The underlying assets can be fiat currencies, cryptocurrencies, a combination of these, and so on.
By being tied to the underlying asset, the price of staplecoins changes less than that of cryptocurrencies. If the market falls, users of cryptocurrency exchanges can withdraw funds into staplecoins to preserve their value. They then wait for prices to fall further and buy more cryptocurrency.
DeFi Stablecoins are used for trading, borrowing, loans and derivatives and so on.
The value of decentralised Stablecoins is ensured by the organisation or cryptocurrency exchange that issued them. It must also adhere to AML and KYC procedures to ensure the safety and security of their crypto-assets.
Most stablcoins are denominated in dollars and are issued by cryptocurrency exchanges. For example, USDT is issued by Bitfinex, USDC by Coinbase, BUSD by Binance and so on.
This is where DeFi applies:
Decentralised Exchanges (DEX). On such exchanges, users can quickly buy and sell tokens with real money, tokens and other virtual assets. They do not need the money in the exchange accounts to do so. Examples of decentralised exchanges are Uniswap and Kyber.
Credit-deposit platforms. Customers of these platforms lend cryptocurrency to other users without the involvement of banks or other intermediaries. For example, Maker DAO, Compound and others.
Insurance. Users can insure their assets if they keep money in smart contracts. For example, in Opyn, Nexus and Mutual.
DeFi-Wallets. These are decentralised wallets in which you can safely store and manage your assets. For example, Melon, InstaDApp and others.
Derivatives. Smart contract technology enables DeFi users to earn from digital security derivatives such as futures, options, forwards and others. For example, UMA and Synthetix platforms.
Exchange protocols. You can exchange one cryptocurrency for another outside exchanges and exchanges.
Prediction markets. Decentralised platforms where users can make their predictions about some events and get something for it. For example, Synetix and Augur services.
Comparison of DeFi with traditional centralised financial systems (CeFi)
In CeFi's centralised financial system, users make transactions through exchanges or trading platforms. They are responsible for all processes and comply with the rules of the country where they operate.
In CeFi, cryptocurrency exchanges store their customers' funds in custodial wallets – those that transfer control of secret keys to a third party. Cryptocurrency companies here operate as lenders who hold and manage their clients' assets. In DeFi, clients control their own assets and own the keys to their wallets.
Here's a list of the main differences between a decentralised financial system and a centralised one
Who issues the money Central Bank Members of the cryptocommunity (miners) mine new coins, which are called tokens. The coins are then put into circulation and used by the cryptocommunity
What counts as money National currencies – hryvnias, dollars, euros and others Cryptocurrencies and tokens – Bitcoin, Ethereum, Solana and others
Who is responsible for lending Banks and credit institutions Decentralised platforms controlled by the community
Who provides asset exchanges Exchanges and brokers Decentralised exchanges that guarantee anonymity, no identity verification and more
What to invest in Securities – stocks, bonds, bills, government bonds, etc. Tokens and cryptocurrencies
In a centralised financial system, participants in the financial market depend on the state, central banks and other intermediaries. In a decentralised financial system, they may rely on technology, software code and encryption algorithms.
Risks of regulation
Despite the popularity of decentralised finance among businesses and individuals, authorities in various countries openly criticise DeFi and see the need to regulate the sector.
For example, in December 2021, Massachusetts State Senator Elizabeth Warren stated that DeFi is the most dangerous part of the cryptocurrency world because there are many fraudsters and almost no one regulates it. In 2021, investors lost about $10.5 billion to theft and fraud. In 2020, the loss was only $1.5 billion.
Gary Gensler, head of the US Securities and Exchange Commission, also talked about the need to regulate the DeFi sector. He believes that DeFi-platforms participants make a profit, which means that their work should be regulated. In addition, Gensler said that DeFi-type projects cannot be considered decentralised because they can be regulated by supervisory authorities.
FATF executive secretary Rick McDonell said that it is too early to say exactly how the authorities will control the DeFi sector.
The risks of DeFi regulation come down to the fact that laws in different countries do not have precise regulations that control the decentralised finance sector. Because of this, there are more and more fraudsters who steal users' money.
To address these risks, in the US, for example, Securities and Exchange Commission Commissioner Caroline Crenshaw has called for DeFi projects to cooperate. The official noted: Because DeFi has little regulation, the sector has a favorable environment for professional investors and insiders. Whereas retail investors cannot do a quality audit to make an informed investment decision.
In addition, participants in the DeFi sector operate anonymously and can manipulate the market with the help of bots.
For example, they can artificially create demand for tokens, and once the price peaks and the fraudsters maximise their profits, they stop creating demand, the price of tokens drops dramatically and ordinary users lose their money.
Commissioner Caroline Crenshaw has proposed regulating the DeFi sector through Securities and Exchange Commission rules.
The decentralised finance sector grew strongly for the first time in 2020 after the launch of the Ethereum-based Compond autonomous lending protocol. Users began actively lending their digital assets and receiving a commission for doing so.
To measure the growth of the DeFi sector, the Total Value Locked (TVL) metric is used. TVL shows how much money users have collectively invested in DeFi projects.
The popularity of DeFi has increased demand for developers of decentralised applications. According to the ElectricCapital Developer report, about 2,500 IT professionals were working in the DeFi sector in 2021. The number of Bitcoin developers increased by 42% and Ethereum by 9% compared to 2020. At the same time, the number of specialists who work with Ethereum blockchain is more than five times the number of Bitcoin developers.
The more the DeFi sector grows, the more customers' money is stolen from it. According to London-based analyst firm Elliptic, users of DeFi, credit platforms and exchanges have suffered more than $12bn in losses since 2020, most of it in 2021.
The decentralised finance sector is a convenient alternative to the traditional financial system with its institutions.
DeFi services and applications have made it possible to borrow and lend quickly and without intermediaries. Blockchain and smart contract technologies have made this possible. They allow everyone with internet access to transact and conduct transactions directly, without having to pay a commission to a third party. DeFi participants can also make money from their assets – lending, creating deposits, and so on.
The decentralised finance sector is set to grow in 2022. DeFi tokens such as Aave, Cardano, Solana and others are worth investing in now.