Decentralized Finance Category

Categorizing decentralized finance is a very challenging problem. Due to its programmable and composable characteristics, decentralized financing system modification is very flexible, and different kinds of services can be created, making them difficult to categorize. However, the classification may be possible by comparing functionalities of the services with the traditional finance as follows:

Stablecoins

It is a kind of digital asset that has been developed to have its value close to the underlying currency or asset. With this characteristic, stablecoins are deeply associated with the issuer in terms of centralized trust and custodian services. Stablecoins can be classified into different categories based on the issuers, which will be discussed further in the next chapter.

Exchanges

This is a service for trading digital assets without having to deposit assets with the custodians or a controllable process, such as order book or matching order.

This service can also be called a decentralized exchange, which uses the automatic market maker, specified in the smart contract, to replace the traditional pricing with algorithmic continuously pricing, which will be continuously adjusted according to current transaction size and liquidity.

Credit

This is a service that involves borrowing and lending. Interest-bearing tokens are minted for lenders and borrowers, and the borrowers have to pay back the loan and interest when the maturity date is reached. Both borrower and the lender have to agree on the loan terms, which can be divided into two main categories: peer-to-peer and pooled capital.

The loaning process in decentralized finance leverages automation, decentralized and non-custodial features to replace the process in traditional finance.

However, taking a loan through such a process doesn’t require borrowers’ credit rating. To prevent a non-performing loan from arising, an over-collateralized loaning process is applied. Alternatively, an uncollateralized loaning process or flash loan can be used to perform quick transactions. This process requires that borrowing and repaying loans must occur and end within one block.

Derivatives

This is the process of creating synthetic financial assets, which are derivatives in nature. The value of derivatives will depend on the underlying assets. Since DeFi has programmable and composable features, the synthetic financial assets that behave like their underlying assets can be created easily, such as stocks, equities, and commodities.

Additionally, derivatives can also be used in different ways. For example, they can be used to create new types of assets, such as non-fungible tokens, which are popular in the arts and real estate business. It can also be used to predict the market based on the wisdom of crowds.

Insurance

DeFi insurance is a service that leverages two features: decentralized transactional and decentralized governance. In practice, insurance contracts are similar to derivative assets that have pay-out when external events occur, as specified in the contract.

The insurance contracts are often used in hedging as Pooled, allowing risks to be distributed proportionally in the Pooled.

Asset Management

This is a service involving managing financial assets for users. The service providers have to look for suitable investments to gain consistent returns for the managed fund. This service can be customized by different factors, such as desired risk level, duration of the investment, etc.

DeFi Asset Management can move the asset management life cycle into Decentralized Application (DApp). It can apply different aspects of blockchain to make transparent and efficient execution and investment strategy for the fund.

Auxiliary Service

This is a service that is not a direct financial service. Instead, it supports financial services, such as oracles, wallets management, data storage, identity verification, etc.