DeFi Coins: Everything to Know
By Beluga Research November 2, 2023
- DeFi coins are digital tokens that enable decentralized finance, because they give users open and permissionless access to financial services
- Decentralized finance (DeFi) is a financial system built on public blockchains, which allows individuals to access financial services without relying on intermediaries
- DeFi coins play various roles within the DeFi ecosystem, including governance, utility and value capture
- The advantages of DeFi coins include financial inclusion, transparency, accessibility, peer-to-peer (P2P) transactions, programmable money and opportunities for yield
DeFi coins are digital tokens that enable decentralized finance, because they give users with open and permissionless access to financial services. These coins allow users to engage in a number of transactions, from borrowing and lending to earning interest. DeFi coins do not require the services of an intermediary such as a bank. The term DeFi refers to financial interactions on public blockchains. The word is often synonymous with Ethereum and coins on the Ethereum blockchain. Yet there are also DeFi coins on many other blockchains.
A Brief History
The concept of DeFi emerged with the introduction of Ethereum, a blockchain that went live in 2015. Ethereum enabled the creation of smart contracts, self-executing agreements with terms written in code. Ethereum's smart contracts later allowed the development of decentralized applications (dapps) that facilitate financial services.
The real breakthrough for DeFi came in 2017 with the advent of the Initial Coin Offering (ICO) boom. During this period, numerous projects raised funds by issuing their own tokens on the Ethereum blockchain. These tokens often represented a stake in the project. They also provided access to specific services within the ecosystem.
Many ICOs turned out to be scams and failed projects. Yet the promotion of so many tokens through ICOs introduced more users to the potential for DeFi. The phenomenon laid the foundation for the development of DeFi tokens and the broader DeFi ecosystem.
DeFi Coins: Everything to Know
DeFi coins are cryptocurrencies that allow users to interact with the DeFi ecosystem.
- Governance Tokens: Many DeFi projects have their own governance tokens. These coins give holders voting rights and decision-making power within the ecosystem. Governance tokens allow participants to influence protocol upgrades, fee structures and other important decisions. Holders of governance tokens usually institute measures to ensure that the platform avoids centralization.
- Utility Tokens: Some DeFi coins are designed to have specific utility within their ecosystems. These tokens are often required to access and use various services or features provided by the DeFi platform. For example, a lending platform might require users to hold a specific utility token to borrow or lend assets. Utility tokens can also be used for transaction fees or encourage general participation.
- Value Capture Tokens: Certain DeFi coins aim to capture value generated within the ecosystem and distribute it to token holders. This value can come from transaction fees, interest generated from lending or borrowing and other revenue streams within the protocol. Holders of these tokens can benefit from the success and growth of the DeFi platform. They can earn passive income based on their token holdings.
- Liquidity Providers: DeFi coins often rely on user-provided liquidity to facilitate trading and other financial activities. Liquidity providers deposit their tokens into liquidity pools. These mechanisms allow others to trade against those tokens. In return, liquidity providers earn a share of the transaction fees generated by the platform. These tokens are known as liquidity provider tokens. They represent the user's share of the liquidity pool. Liquidity provider tokens can be redeemed for the user's portion of the earned fees.
- Open and inclusive nature. Traditional financial systems often impose barriers. DeFi coins allow anyone with an internet connection to participate in the crypto ecosystem.
- Acquire a digital wallet. A digital wallet allows a user to hold DeFi coins.
- Engage in financial activities involving DeFi coins. These include lending, borrowing, trading and earning interest.
- Use of smart contracts. These are self-executing agreements encoded on the blockchain. They automatically execute predefined conditions when certain criteria are met. Smart contracts eliminate intermediaries. They ensure trust and transparency in transactions.
- Liquidity pools. Liquidity pools consist of funds contributed by users. They enable decentralized exchanges and lending platforms to operate smoothly. Users can contribute their digital assets to these pools and earn rewards. Liquidity providers play a crucial role in ensuring there is enough liquidity to trade and lend assets.
- Offer opportunities for earning passive income. One popular method is yield farming. This involves users providing liquidity to decentralized platforms and earning additional tokens as rewards. The profit incentivizes users to contribute to the ecosystem. Yield farming increases liquidity and drives the growth of DeFi.
- Interoperability . Many DeFi projects are built on open, interoperable blockchains. This technology facilitates users seamlessly interacting with different platforms and utilizing a wide range of financial services. Interoperability fosters innovation and collaboration within the DeFi space. It enables developers to leverage existing infrastructure and build upon one other's work.
- Financial Inclusion - DeFi coins offer the potential to provide financial services to unbanked and underbanked populations worldwide. By eliminating intermediaries like banks, entities can access services such as lending, borrowing and saving. Education and outreach may be necessary to involve novices and parties that lack a high amount of funds.
- Transparency - These coins operate on public blockchains. The blockchains make transactions and smart contracts visible to anyone. The transparency enhances trust and reduces the risk of fraud. It allows users to verify transaction integrity.
- Accessibility - DeFi coins enable anyone with an internet connection to participate in DeFi activities.
- P2P Transactions - Using DeFi coins can facilitate direct peer-to-peer transactions without intermediaries. They reduce reliance on centralized authorities.
- Programmable Money - DeFi coins are built on smart contract platforms. This enables the automation of financial agreements without intermediaries. Automation improves efficiency and reduces costs.
- Yield Farming - DeFi coins offer opportunities for yield farming. They allow users to passive income by providing liquidity to decentralized exchanges and lending platforms. This concept attracts users looking to maximize returns on their digital assets.
- Security Risks - Although blockchain technology enhances security, DeFi coins are not immune to risks. Smart contracts can have vulnerabilities and be subject to exploitation. Users must be cautious about phishing attacks, scams and vulnerabilities in dapps.
- Regulatory Uncertainty - The regulatory landscape for DeFi coins is still evolving. Unclear regulations and potential regulatory actions introduce uncertainty. Changes can impact adoption and development.
- Market Volatility - DeFi coins can experience significant price volatility due to factors like market speculation and liquidity fluctuations. Users should be aware of these risks. They should be prepared for potential losses.
- Limited Adoption - DeFi coins and dapps represent a small portion of the overall financial market. Adoption may be limited to tech-savvy individuals or early adopters. It may take time to cultivate mainstream integration with traditional financial systems.
- Scalability Challenges - Many blockchain networks supporting DeFi coins face scalability challenges. Increased participation can lead to network congestion and high transaction fees. This affects user experiences. Efforts are underway to address these challenges through layer 2 solutions and scaling techniques.