DeFi applications include lending and borrowing, spot exchange, derivative exchange, stablecoin, assets management, and synthetic assets creation.
With the development of DeFi industry, Messari also made a definition for decentralized financial assets. As a token expects to be "part of DeFi", it should meet the following requirements:
Financial use case: the protocol must be explicitly geared towards financial applications such as credit markets, token exchanges, derivative/synthetic asset issuance or exchange, asset management, or prediction markets.
Permission-less: the code is open-source allowing any party to use it or build on top of it without going through a third-party
Pseudonymous: Users do not need to reveal their identity
Non-custodial: Assets are not custodied by a single third-party
Decentralized governance: Upgrade decisions and administrative privileges are not held by a single entity or at least a credible path exists towards removing them
Lending and Borrowing
DeFi protocols allow users to borrow and lend their assets. All DeFi lending today is now over-collateralized, which indicates users must post collateral in excess of the number of assets they borrow. The dynamic resembles a mortgage in which individuals hold their properties in pledge and receive a loan against it. Users could post various assets as collateral and borrow other cryptocurrencies against it including stablecoins via DeFi protocols. While a borrower’s collateral value slumps below a specified loan-to-value ratio, their collateral will be liquidated to ensure the protocol stays solvent.
Notable examples cover Maker, Aave, Compound.
Decentralized exchanges, or DEXs, serve as peer-to-peer marketplaces that enable direct cryptocurrency exchanges between two interested parties. DEXs’ goal is to settle down some fixed problems in centralized exchanges, such as centralized custody of assets, geographic restrictions, and asset selection. The currently popular DEXs adopt automatic market maker but rather a traditional order-book. Unlike the traditional measure of matching individual buy and sell orders, users can deposit assets into a pool that is then traded against, as the price was determined based on the ratio between the assets in the pool. Such DEXs enable users to passively provide liquidity to make markets for any asset on Ethereum as well as provide always available liquidity for traders.
Notable DEXs include Uniswap, 1inch, Sushiswap, Curve, Kyber, and 0x.
Stablecoin refers to a token pegged with another asset to maintain a stable price. These tokens could be pegged with fiat currencies like the U.S. dollar, other cryptocurrencies, and precious metals. The most important thing is that most cryptocurrencies are hard to use for transactions owing to their extreme volatility. The popular stablecoins at present are mostly pegged with the U.S. dollar, there have been three kinds of stablecoin implementations: fiat-collateralized (each stablecoin is backed by a fiat currency in a bank account), crypto-collateralized (each stablecoin is backed by cryptocurrencies in a smart contract), and algorithmic (each stablecoin is backed by an incentivized system that ensures the price stabilizes at its target). Apart from price stability, stablecoins provide a borderless payment system that is faster, cheaper, and more secure than traditional networks like SWIFT.
Notable examples include DAI, USDT, and USDC.
Synthetic assets are financial instruments that simulate the value of another asset. There are many measures to fulfill such value simulation, but, it is usually achieved through the use of price oracles which ensure the asset tracks its target value. There are infinite possibilities to the types of synthetic assets that can be created using crypto assets and the existence of these assets on public blockchains like Ethereum means more open access for investors all over the world. Before assets were created, merely a select few had access and permission to global financial markets. Synthetic assets could offer value for investors like more diversified capital allocation, hedging opportunities again risk, and tools to increase the return on investments.
Notable ones are Synthetix and UMA.
Derivative - options, futures, and perceptual Contracts
In traditional finance, a derivative is defined as a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is usually short for the “underlying.” Despite that traction has still been limited so far relative to other DeFi protocols like lending, exchange, and stablecoins, volumes on derivative exchanges have surged tenfold throughout 2020. Platforms like Synthetix, Yearn.finance, and Hegic have given validity to DeFi derivatives DEXs.
Notable Options and Futures exchange platforms: Hegic, Opyn, Synthetix, Perpetual Protocol, Futureswap, and Alpha Homora.