DeFi stands for decentralized finance and represents a category of financial products and services built on blockchain technology.
By removing the intermediaries used in traditional financial products and services, financial systems become accessible to a broader spectrum of users. The development of the DeFi ecosystem removes many of the traditional barriers to access financial services, such as preferential terms, identity requirements, credit scores, and arduous pre‐qualification paperwork, allowing anyone with an internet connection and access to crypto assets to participate.
And participation in DeFi is booming; DeFi Pulse data shows that over $13 billion USD was locked in Ethereum‐based DeFi applications as of November 2020, and over $54.9 billion USD is locked in as of June 2021. Over the course of 2020, the average Ethereum block size has nearly doubled, increasing from approximately 22,415 bytes to 40,265 bytes. This increase is partially attributable to the boom in DeFi participation—an increased volume of complex DeFi transactions led miners to set higher gas ceilings, resulting in larger block sizes.
DeFi projects typically take the form of decentralized applications (referred to as dapps). Exploring how they work differently from the centralized applications that form our current status quo illuminates many of the benefits of DeFi systems overall.
Standard, centralized applications call data from a centralized server; for example, when Jane logs into her bank’s online app on her smartphone, the app checks the bank’s data server in the bank’s data center to ensure her password is correct and then loads her account balances. All of her information is controlled by that one entity, and she must trust the bank to accurately maintain the record of her account balances and securely maintain any of her other personal data.
In contrast, a decentralized application calls its data from a blockchain (or other P2P network), generally using a combination of wallets and smart contracts. Because the application's data and business logic is stored in a blockchain, which is usually decentralized in nature, the application itself is decentralized. No single entity controls a user’s data; smart contracts and cryptography are used to share the information around the network in a secure manner.
The basic features of dapps’ design, as compared to centralized applications, highlight some of the reasons why people are excited about DeFi:
Other highlights of DeFi include:
Decentralized exchanges are platforms that allow for peer‐to‐peer exchanges of digital assets. Pools of digital assets and derivatives are managed by a smart contract, and are used to enable DeFi lending and trading. The liquidity pools and smart contracts replace the order book system; liquidity providers lock their assets into the pool and earn fees when people trade in these pools in exchange for providing liquidity.
Yield farming, also referred to as
Collateralized borrowing and lending platforms enable people to borrow against their crypto assets or earn savings as a liquidity provider, leveraging their asset’s value without needing to sell. Users can lock a specified asset into a smart contract as collateral and take out an over‐collateralized loan against that asset; in these protocols the collateral is loaned elsewhere to gain greater yields, which offset the loan and any interest being charged on it. Users can also earn a return on their deposited savings by providing liquidity for borrowers, often earning a higher rate than most traditional savings accounts. For borrowers, unlike in traditional borrowing mechanisms, DeFi loans often do not have a set repayment schedule. As long as the borrower leaves their collateral deposited, the loan can remain open.
The above categories represent only a tiny fraction of the DeFi projects currently blossoming within the new and growing field. DeFi insurance providers can use pooled capital to maintain capital efficiency while allowing claim validity, underwriting, and governance to be determined by token holders. DeFi equivalents of hedge funds use smart contracts’ self‐executing functionality to follow active investment strategies replacing actively managed funds. From earn‐as‐you‐work payment applications to building asset management strategies for other users to participate in, DeFi’s composability and smart contract functionality leads to limitless possibilities for development.
Just a few examples of popular DeFi protocols include Uniswap, a decentralized exchange; dydx, a perpetuals contract trading platform; Yearn, a gateway to other DeFi applications with community‐driven investment strategies; Aave, an open‐source protocol for earning interest and borrowing digital assets; Metamask and Argent, both Ethereum‐based crypto wallets that also enable investing, borrowing, and saving; Anchor, a Terra‐based savings and yield protocol; and RabbitHole, a gateway to new DeFi projects that offers rewards for exploring the space.
Participating in DeFi comes with greater risk than simply purchasing tokens. Consider that in most cases, when purchasing a layer‐1 cryptocurrency such as ETH or BTC, you are trusting a vastly distributed network with years of transaction history and development efforts. In contrast, many DeFi protocols are relatively new (or spring up overnight) and are possibly built by untested individuals or teams. On top of that, high yields in the early days are used to attract participants and can lead many well‐intentioned users to dive in head first without proper testing of the project.
URL hacks, fatal code flaws or vulnerabilities in smart contracts, and "rug pulls," a common term for a project that masquerades as a decentralized or open‐source project but is actually controlled by a single entity who absconds all users’ funds at once, are all common risks in the DeFi space. To mitigate the risk involved in DeFi participation, research any DeFi projects you are considering investing in; ensure that the project has a verifiable development team, that its smart contract has been independently audited, and check to see what kind of chatter surrounds the application in the ecosystem—projects with established communities are generally the safest because they are focused on the long‐term development and services of the project.
In addition to the risk of scams, DeFi also comes with many market‐driven risks. Volatility is a given, as users pull liquidity in and out of projects frequently to seek out the highest yields in the space. There may also be tax implications for token swaps, purchases, and earnings, and most transactions require paying significant fees.
Overcollateralized borrowing/lending DeFi protocols present liquidation risks for borrowers. When the value of the collateral asset becomes too close to the value of the loaned asset, the protocol calls your position and seizes your collateral. This is referred to as a margin call. Although you do not need to repay the borrowed assets, the loss of the underlying collateral can be disruptive to one’s overall financial planning and crypto savings goals.
Another risk factor to consider in DeFi is impermanent loss, or when the value of assets provided as liquidity in an automated market maker changes during the course of the investment, leading to missed market gains. This can lead to a withdrawal scenario in which a person’s asset would have gained more in value from simply holding it through market changes than the person earned as a set rate from being a liquidity provider.
"For all intents and purposes, DeFi was not a thing two years ago–it was just a few folks at a meetup who were talking about this idea that we could have finance that was built using smart contracting platforms and systems. [Now] new protocols, new pieces of technology that fit into the different protocols–everything from liquidity pools to automated market-making to lending to insurance: literally everything across the board is sort of being built in the decentralized finance space."—Joe Lallouz speaking to Finance Magnates in September, 2020.
Developers are involved in all components of DeFi, from building protocols to dapp development, auditing smart contracts to supporting product upgrades. Most projects have open Q&A sessions, Discord channels, and sometimes even open GitHub repos, for those looking to start anew as a DeFi developer to get involved. Many projects share about these opportunities, and the other developer opportunities within their broader ecosystems, on Twitter and other social media platforms.
Bison Trails builds for the protocols supporting DeFi solutions. Whether we’re offering query and transact nodes for Ethereum, powering eth2 staking, testing network upgrades and running the Terra Foundation’s public Terra validators, or operating the seed nodes to keep Crypto.org Chain operating smoothly, we support the fundamentals underpinning the growth of the crypto and DeFi ecosystems.
For those already working on developing DeFi solutions, Query and Transact by Bison Trails offers an easy on‐ramp for developers and early‐stage applications to access the blockchain data necessary for their products and services. Query and Transact breaks down barriers to entry in DeFi and fosters experimentation by enterprises, DAOs, foundations, and individuals by offering the ability to query data from and write data to your preferred blockchain, without needing to develop the engineering know‐how to do so in‐house. QT’s read/write infrastructure is fully managed by Bison Trails and offers builders the ability to easily scale usage, allowing DeFi developers to focus time and resources on their products rather than their infrastructure.
Query and Transact is available not only for Ethereum, the current hub of DeFi activity, but for a number of other protocols just beginning to get traction in the DeFi space. The possibilities are endless: integrate Acala products into your offering, develop a lending protocol for Solana, create a savings product on Terra, and more.
A: “We’ve been heavily focused on infrastructure at the protocol level: message propagation, securing, validating, or governance in Proof of Stake networks [for example]. All of the DeFi systems currently being built—whether they’re Automated Market Makers (AMMs) or DEXs (decentralized exchanges)—are built on top of protocols that assume a certain level of security. So if they’re built on top of Ethereum, people are securing Ethereum. If they’re built on top of Polkadot or Tezos, people are securing those networks.
Bison Trails focuses on securing the protocols themselves and making them usable. So if you’re building a product or service that interacts with Ethereum, you might be using Bison Trails’ infrastructure to read or write to and from the network. It’s not so much that we’re building products for DeFi, but we’re building a lot of the fundamentals that support a DeFi ecosystem that can grow and can be used. We’re less focused on tools to optimize yield farming or anything like that. We’re focused on the fundamental layers.” —Joe Lallouz, CEO of Bison Trails at REIMAGINE 2020
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Bison Trails is a blockchain infrastructure platform-as-a-service (PaaS) company based in New York City. We built a platform for anyone who wants to participate in 25 new chains effortlessly.
We also make it easy for anyone building Web 3.0 applications to connect to blockchain data from 33 protocols with Query & Transact (QT). Our goal is for the entire blockchain ecosystem to flourish by providing robust infrastructure for the pioneers of tomorrow.
In January, 2021, we announced Bison Trails joined Coinbase to accelerate our mission to provide easy-to-use blockchain infrastructure, now as a standalone product line. The Bison Trails platform will continue to support our customers. With Coinbase’s backing, we will enhance our infrastructure platform and make it even easier to participate in decentralized networks and build applications that connect to blockchain data.