What is Decentralized Finance (DeFi)?

The first and still best known cryptocurrency is bitcoin. You hear about bitcoin from every newspaper and you probably had to spend the last couple of years in a cave somewhere meditating with Buddhist monks to not know anything about it. Although who knows, maybe the monks are already mining a bit… Following bitcoin came the ether blockchain. It solved one serious problem – it greatly expanded the ability to create smart contracts, which in turn expanded the applications for cryptocurrencies. While bitcoin is mostly either used for speculation or for long-term investments (HODL!), the ether blockchain, thanks to smart contracts, has grown an entire ecosystem of financial services, which today we call decentralized finance (DeFi).

Nevertheless, the experimentation did not stop with ether. Ether has a significant disadvantage at the moment – the bandwidth of this blockchain is only a few dozen transactions per second. Due to the very high popularity of DeFi and NFT, the network is constantly overloaded and this leads to very high transaction costs. Any simplest transaction on ether costs hundreds of dollars.

New blockchains have emerged as an answer to this problem – Solana, Tera and Avax are the most popular of the alternative blockchains, they can support from several thousands to tens of thousands of transactions per second, thus reducing transaction costs by about 1,000 times. On the Terra blockchain, for example, small transactions cost a few cents.

An ecosystem of financial applications and services (they are called dApps / decentralized applications) based on smart contracts on the ether blockchain and other alternative blockchains is decentralized finance (DeFi).

The total capitalization of investments in various DeFi applications and services is currently about $230 billion, and it has grown about 10 times in the last year.

Deposit at Anchor

The Anchor protocol can be called a crypto-bank. It allows you to borrow against cryptocurrencies and accepts deposits at interest. The token in which deposits and loans are accepted is the UST Stablecoin, which is equal to one dollar. The idea is that if you want to borrow $100, you need to provide collateral in cryptocurrency, at least $200. The protocol has two sources of yield: first is the interest on the loan paid by the debtors, and second is the staking yield of this cryptocurrency as Anchor uses tokens received as collateral for staking, as described above

Example: someone borrows $100 and provides a $200 LUNA token as collateral. First, he pays interest on the loan, about 15% per annum, and second, the $200 pledge yields a 7% return.

On the other hand, the deposits pay 19.5% p.a. at the moment.

Criticism and risks:

lately this protocol has been attracting significantly more deposits than it is lending, accordingly the high yield is likely to decline very soon, or they will limit the acceptance of deposits;

At the moment, Anchor is trying to attract new borrowers by offering them cashback, part of the interest paid on the loan in the form of their own token ANC, this can be compared to the fact that Sberbank would give you back half of the interest paid on the loan in the form of their shares. This maintains interest among potential debtors, but it leaves interest in the protocol in question after they discontinue this subsidy;

This practice of giving subsidies to early protocol users is a popular practice in DeFi. It can be compared to how Uber lost money on every ride for years, but focused on growing its customer base and overall turnover.

there is a risk that the smart contract of this protocol will be hacked and your entire contribution will be lost forever, such hacks at DeFi happen quite regularly

There is a risk that the UST token will stop being worth $1, this has happened in the past during the general collapse of cryptocurrencies, it went down to about $0.85 last May.

The point is that it is an algorithmic stablcoin that is not backed by real dollars. Its parity with the dollar is maintained in a different way, more on that here. The concept of algorithmic stabcoin itself is an experiment whose success is not guaranteed.

Pros:

The smart contracts of this protocol have been audited three times by a third-party audit that confirmed no vulnerabilities, no hacks have occurred so far;

it is possible to buy smart-contract insurance, it means that if the protocol suffered a hacker attack and you lose your money another insurance protocol will reimburse them to you, the cost of such insurance is 2% per year at the moment;

even if the return on deposits falls by half, it will still give a fairly high return. It is clear that today’s high yield is not forever;

The most important plus in my opinion is the business model of credits secured by cryptocurrencies: it is similar to a loan against securities at a broker with the difference that the cryptocurrency market is open 24/7, i.e. in case your collateral falls below the minimum collateral level the collateral will be automatically sold on the market with a small discount and the loan is closed from these funds.

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