December 3, 2021

Decentralized Finance Guide

Carla McMorris
Director of Content

How Fintech Companies Leverage Decentralized Finance for Competitive Advantage

What is Decentralized Finance?

Decentralized Finance or DeFi is a general term that describes a financial ecosystem built on decentralized applications using blockchain technology. With DeFi it’s possible to offer financial services like those provided by traditional banks and insurance brokers.

Born of the mission to bank the unbanked, DeFi is built on the premise that a decentralized financial system based on open-source protocols and smart contracts can replace traditional financial services that rely on intermediaries. Smart contracts automatically execute transactions based on pre-determined conditions. 

DeFi is transparent and accessible software that’s available to everyone. Because DeFi operates without intermediaries or centralized institutions it can combine services like lending, trading, investments, payments, asset management, and insurance more flexibly than traditional financial services.

Is DeFi a cryptocurrency?

Yes, DeFi is a newer part of the cryptocurrency ecosystem that was built on blockchain technology that powers other cryptocurrencies like Bitcoin. DeFi, however, has magnified the simple transactions of most cryptocurrencies into more complex financial transactions that can be used across more use cases. DeFi’s smart contracts power its complex financial transactions automatically executing transactions based on pre-determined conditions. Most DeFi projects are built on the framework of another popular open-source blockchain called Ethereum. Ethereum has its own cryptocurrency called Ether that is second only to Bitcoin in market capitalization. 

Where did Decentralized Finance come from?

DeFi has been built on layers of blockchain technology over the past 10 years, starting with the distributed ledger which enabled peer-to-peer transfers. In 2015, Ethereum was the next layer of functionality for DeFi with its native programming language. The final layer came in 2017 with the first coin offering. Built on these technologies, DeFi is a combination of these innovations.

What is Ethereum?

According to Ethereum Foundation, “Ethereum can be used to codify, decentralize, secure and trade just about anything.” Ethereum is a decentralized computing platform based on open-source blockchain technology with smart contract functionality. The openness and security of the Ethereum blockchain empower developers to build a wide variety of applications like gaming and databases, including the robust financial tools that it’s known for with DeFi. The Ethereum platform has its own cryptocurrency called Ether which is second only to Bitcoin in market capitalization. Vitalik Buterin conceived Ethereum in 2013.

Why is Decentralized Finance so popular?

The total value in DeFi contracts has exploded in recent years, driving the value of tradeable tokens that are used for DeFi smart contracts even higher. There are several reasons for the buzz and excitement around DeFi:

  • Many investors have seen the growth of DeFi tokens and they don’t want to miss out on the next surge in value.
  • Interest rates are at historic lows which makes DeFi’s much higher interest rates very attractive to consumers and businesses looking for higher rates.
  • Regulators and some mainstream financial institutions are starting to take DeFi seriously.

How are fintechs leveraging the DeFi boom?

Innovative fintechs are integrating cryptocurrency services with traditional banking products like savings accounts and investment accounts. These hybrid products leverage decentralized finance to offer well above average earnings on high yield savings and investment accounts for their end-users. Fintechs work with banking-as-a-service platforms that specialize in cryptocurrency to convert their end user’s US dollars into stable coins. Then, through a pool of lenders and borrowers in the DeFi ecosystem, end-users enjoy variable yields as high as 10% APY.

How does DeFi lending work?

Lending and borrowing are the most popular uses of DeFi applications. With DeFi lending, users can lend cryptocurrency and earn interest, often much higher interest, just like a bank. If you lend money through a DeFi protocol like Maker you would begin by sending assets into a “money market” using a smart contract. Your assets become coins available for users to borrow, and later, the platform will issue interest tokens to you. When you’re ready to redeem your assets they will be issued in the platform’s tokens, for example, Maker’s tokens are called Dai. 

If you’re interested in taking out a DeFi loan it’s easier to borrow than with traditional banks. The only requirement is to lock crypto assets as collateral like a crypto guarantee that is worth more than the loan itself. These over-collateralized loans are the norm in DeFi lending and a side effect of not having to provide any personal credit history for the loan.

How does DeFi pay such high-interest rates?

Some consumers are accessing cryptocurrency exchanges directly by sending crypto to a DeFi lending pool that others borrow from. The lender is paid interest based on supply and demand. 

Others are using financial services apps that work with vertically integrated platforms and APIs to design a connected banking and crypto product that enables US dollars to automatically convert to stablecoins. The application then lends those dollars through a global pool of crypto lenders and borrowers resulting in higher-yield savings accounts.

What’s the difference between CeFi and DeFi lending?

Borrowing and lending via cryptocurrencies can be conducted in two ways: CeFi and DeFi.

CeFi or Centralized Financing are platforms work much like a traditional bank in that they are centralized institutions that take in money from depositors then loan it out to others paying a set interest rate.

DeFi however is a decentralized system that lets individuals be either borrowers or lenders based on smart contracts. DeFi platforms can be used by anyone without sharing any personal data, keeping complete control over their finances.

Is Decentralized Finance right for your business?

If your company is looking to distinguish its brand and become a financial partner to your customers, DeFi may be the right product for you. This innovative solution elevates traditional financial products with crypto technology and cryptocurrencies that currently return high yields on savings accounts when banks are having a difficult time yielding 1.00% yields. 

Synapse provides modular building blocks to develop and launch custom suites of financial services to embed banking products, issue cards, provide next-generation loans, and more, quickly, reliably, and securely. Innovative companies use Synapse’s range of products to integrate crypto and banking products for their customers while leveraging multiple partner bank services.

If your business needs support to bridge modern payment solutions between you and your customers, we’re here to help.

Decentralized Finance Guide

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Carla McMorris
December 3, 2021

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