DeFi projects are decentralized financial applications that provide alternate banking and related services without needing third-party services, paperwork, and physical contact.

While DeFi projects can presented as a sustainable alternative to traditional finance methods, it is an emerging technology. Considering this, it is important to scrutinize DeFi projects before investment and use.

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Functions of DeFi Projects

These are some of the functions of DeFi projects.

Sending Funds

DeFi projects can be used to send an unlimited amount of funds to different wallets around the world without obstacles. These wallets would have to be hosted on the same blockchain. For example, if the sender sends ETH, which exists on the Ethereum blockchain, the receiver needs to have an Ethereum-compatible wallet for the transaction to be successful.

Lending and borrowing of Digital Assets

Various lenders can deposit funds in liquidity pools. Borrowers have the option of taking loans from these liquidity pools and setting up their digital assets worth the same amount, mostly crypto tokens, as collateral.

It is a win-win situation for both parties as it is an anonymous transaction. Lenders can also gain from staking their funds when the interest rates of an asset spike in the crypto market. In situations where the borrowed funds are not returned, the lender can liquidate the collateral to regain it.

Staking

Staking is an essential DeFi component that protocols can use to strengthen their governance. Staking is the act of locking up crypto tokens on a blockchain. This is a symbiotic partnership that promotes the blockchain network’s security and incentives for the owner.

Yield Farming

Yield farming is a similar practice, however, the funds are deposited in liquidity pools to facilitate lending and borrowing activities. Interests are earned in the form of transaction fees and additional tokens. Both components are a source of passive income for participants.

Interoperability

DeFi protocols are interoperable. This means that different protocols like cross-chain solutions can interact amongst themselves on the blockchain system. Examples of such cross-chain solutions are cross-chain swaps, sidechains, liquidity pools, and atomic swaps. Interoperability promotes innovation, maintains efficiency, and prevents the need for intermediaries for transactions on the blockchain network.

Easy Access

All of your digital assets can be accessed easily, at any location in the world. Requirements needed are a mobile device or a computer and an internet connection. Transactions involving the sending and receipt of tokens can be carried out seamlessly.

There are various types of DeFi projects, and they are classified according to their functions.

Types of DeFi Projects

Lending and Borrowing Platforms

These are lending platforms hosted on the blockchain network that enable lending and borrowing. Most of them also offer trading services. Trustees and guarantors are not needed. Borrowers however need to provide collateral to engage in peer-to-peer transactions.

Investors and borrowers are advised to make informed decisions by watching market trends for possible mishaps, and the amount of funds they can bear to lose, in cases of sudden volatility.

Examples of popular lending and borrowing platforms are Synthetix and Yearn.Finance, bZx, Balancer, Uniswap, Aave, dYdX and many others.

Decentralized Exchanges (DeX)

These are exclusive crypto marketplaces where transactions are carried out between traders. They are open-source smart contracts that use liquidity pools for trades, publish a list of cryptocurrencies according to their current market value, and conduct transactions with the aid of an order book, as seen in stock exchanges.

Interested individuals will need to connect their crypto wallets to a DeX. These wallets will need to contain Ether or ETH for transactions and DeX fees. Some DeX requires other tokens though. Examples of decentralized exchanges are Uniswap, Curve Finance, Pancakeswap, Trader Joe and Orca.

Yield Farming and Staking Protocols

These are decentralized platforms that provide passive income. Users deposit funds in liquidity pools or stake them in the prospect of added interest and higher returns. Yield farming encompasses lending and borrowing, staking, and liquidity providing. Examples of platforms that offer yield farming services are Uniswap, Curve Finance, Pancakeswap, and others.

Synthetic Asset Platforms

Synthetic assets are digital tokens created to represent real-world assets with monetary value. Examples of these real-world assets are gold, stocks, and currencies.

The users do not need to own these real-world assets. Synthetic asset platforms provide an avenue for its users to create synthetic assets and trade with them on decentralized platforms. Examples of these platforms are Abra, The Mirror Protocol, UMA Protocol, Synthetix, and others.

Derivatives

They are legally binding contracts that derive their financial value from underlying assets such as stablecoins and cryptocurrencies. Smart contracts determine their expiration, strike price, underlying asset, and medium of exchange.

Derivatives can be traded on decentralized exchanges (DeX) without intermediaries and trustees. Examples of platforms that allow these transactions are Synthetix, dYdX, UMA Protocol, and others.

Bridges

These are software protocols that enable interoperability and transaction of assets across chains. True to their name, bridges allow several DeFi platforms to interact with each other, including the transfer of native tokens to other networks.

There are two types of bridges: one-way and two-way bridges. One-way bridges permit assets to be moved from the source to the receiver blockchain only and end the transaction hereafter. Two-way bridges allow blockchain networks to conduct back-and-forth transactions.

Bridges are also classified according to two categories: trusted and trustless bridges. Trusted bridges, also known as centralized bridges, require a third party or a custodian to make the connection between two blockchain networks for a successful transaction. Trustless bridges do not require custodians and third parties. Instead, they use smart contracts, and their users retain their assets while transactions occur till transfers are done.

Considering market trends, it is expected that DeFi will gain predominance in use. With its maturity, effective governance regulations will be established, making it a key player in global finance transactions.