Decentralised finance (DeFi) is a buzzword that refers to a new kind of financial system built on blockchain technology that aims to make finance easier and cheaper by removing intermediaries such as brokers and exchanges.

Here, DeFi achieves its objective of automating processes through so-called smart contracts on cryptocurrency blockchains – notably Ethereum – that underpin the whole gamut of DeFi products from peer-to-peer lending/borrowing/token swap/NFT trading/yield farming and more.

Decentralized Exchanges (DEXs)

In offering an immune-system escape from the centralised financial system – ie, cryptocurrency exchanges that demand users relinquish control over their crypto to third-party business entities that would store and conduct trades on their behalf – DEXs offer the possibility of replacing centralised systems with something based on blockchain technology that facilitates trustless peer-to-peer trades between two peers with lower costs, risks and barriers to entry, thus having the capacity to expand financial services across socioeconomic groups in a manner previously impossible.

Certain DEXs even support on-chain trading, which runs the actual swap on the blockchain and has the transactions verified by miners of the network – this might cause slower speeds and lower liquidity, but everything is as decentralised as it gets.

Some DEXs are off-chain, where an order is actually posted directly into an order book rather than recorded in the blockchain. While not quite as distributed as on-chain, this approach might facilitate faster and higher demand orders while possibly reducing the security risks that come from on-chain transactions.

Automated Market Makers (AMMs)

AMMs are programmed to perform cryptocurrency trades at predetermined prices, specified in the code of a smart contract. AMMs form the linchpin of decentralised exchanges (DEXs), which allow users to trade cryptocurrency without the need for a central counterparty.

Users deposit tokens into pools that offer liquidity, and the platform (comprising an algorithm known as an AMM) can transact tokens through peer-to-peer transactions; these exchange rates are determined by mathematical formulas, which aim to keep liquidity in balance as transactions occur.

Different flavours of AMM models given particular challenges. A Dynamic AMM, for instance, uses multiple inputs in order to responds rapidly to quick moving market conditions, helping to protect traders from having to front impermanent loss while also minimising levels of slippage during periods of low volatility.Other popular types of AMM models include so-called Uniswap and Balancer formulas.

Lending Platforms

Decentralised Finance is a growing subsector of the crypto and blockchain technology ecosystems enabling the construction and usage of open financial services. DeFi plans to replace existing systems by removing the locus of power, risk and trust from central third-party institutions.

DeFi is a new system that leverages cryptocurrency to maintain a ledger without banks, financial institutions or other middlemen, and ensure access to financial services to those who normally suffer a lack thereof, whether that’s due to income, country of origin or credit history. The more DeFi evolves, the more necessary it becomes for financial advisors to keep a finger on the pulse on both present advancements and future opportunities as your clients begin using programmes such as Uniswap or Aave to trade synthetic assets.

Stablecoins

Stablecoins are digital currencies pegged to existing fiat value, for example a dollar of the US dollar. They are valuable mainly as units of account, with the relative stability of fiat currency. So, stablecoins might be used to make payments or as collateral to loans or to trade on DeFi platforms.

Stablecoins can take different forms, the most common of them tied to cash or to what’s known as ‘cash equivalents’: bank deposits, money market funds or Treasury bills.

A number of stablecoins are covered by assets other than cash – commodities and goods of physical value. While this method introduces risk, because commodities and gold are non-regulated assets, stablecoins based on asset coverage have proliferated, as these are also the easiest way for users on decentralised lending and borrowing platforms to lower the volatility.

Yield Farming

For investors there are enticing opportunities to earn much better rates of return than you would from putting your money into a savings account or by investing in stocks and shares. Meanwhile, with yield farming, your investment is likely to go down in value if the prices of crypto assets to which your funds are exposed drop – and your money could well be lost if the smart contracts that a yield farm uses contain bugs or if they are hacked.

The tokens may also experience price volatility and temporary loss due to risk factors. One way you can minimise this risk is to move the coins you deposit into an asset-backed stablecoin. Some staking protocols may also have fixed lock-up periods in which you won’t be able to continue to earn, but once you do your homework you’ll find many with shorter lock-up periods as well, plus safer than some yield-farming platforms.