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Key DeFi Ecosystem Problems, Explained



The DeFi market is made up of many different actors and subsectors, some of which simply don’t exist in traditional finance. While a large majority of participants include lenders looking to loan out assets, borrowers looking for quick access to those assets and exchanges that can act as a medium for lenders and borrowers, there are a number of other important facets and solutions. These include peer-to-peer marketplaces, the tokenization of real-world assets such as real estate and art, prediction markets, staking and collateral, alternative savings with interest earning mechanisms and even insurance.

One of the most popular use cases in DeFi today is lending and borrowing. Lenders are generally players who hold a significant amount of assets and are looking for ways to earn interest on their holdings that transcend normal market appreciation. By providing liquidity for an asset, long-term lenders are often rewarded when they use a specific lending platform. This comes as a win-win by adding liquidity to an asset’s market while giving passive income to those providing it.

Borrowers are seeking benefits that come with temporarily taking control of lenders’ resources, even if for a price. For one, by borrowing an asset, users can potentially short that commodity for profit on exchanges that do not support margin trading. Furthermore, these platforms can offer quick access to utility tokens that the borrower may not wish to hold, but simply wants to use for one specific task, such as participation in voting on a network. There are even “flash loans” available — a financial tool that enables users to request a loan, use the money borrowed and reimburse the loan atomically in a single transaction. 

Decentralized exchanges have also gained popularity for their automated swap capabilities. The only “middleman” is a smart contract, which does not take a cut or slow down the exchange process. Funds remain in a user’s full custody, minimizing the security issues that have caused centralized exchanges to lose tens of millions of dollars in cryptocurrency due to hacks or mismanagement. 

Liquidity pools are another emerging avenue of DeFi, and are often tied to decentralized exchanges. Some decentralized exchange, or DEX, platforms like Bancor Network and Uniswap encourage users to create and fund the liquidity pools needed to facilitate different exchange pairs. If you have a token and would like to exchange it with another, you can add liquidity for that token so others can swap and trade for it. This open process undermines the concept and process of getting listed on the traditional stock exchange.

Both DEXs and liquidity pools have experienced the largest growth ever since their inception in the past quarter.

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