DeFi

What is Decentralized Finance?

Decentralized Finance, sometimes called Open Finance, or most commonly DeFi, is an effort to build a better kind of finance on top of public blockchain protocols.

DeFi embodies the values of public blockchains like Ethereum, and builds them into new financial applications.

• DeFi is open, there are no gatekeepers and there is no need to identify yourself.
• DeFi is permissionless! We built rTokens without asking for any permission from the protocols we are built on.
• DeFi is trustless. Our contracts execute without any manual intervention. Nobody can touch your money.
• DeFi is open source! All our contracts are public. Verify them on etherscan.io or with your own node.

As decentralized finance is built on anonymity, credit checks are hard to perform, so users are always asked to deposit collateral when taking out a loan.
As a result, DeFi protocols are all "overly collateralized". If a debtor becomes insolvent, their collateral is liquidate, and for this reason you will always be able to redeem your rDAI for DAI.

We believe in building a Decentralized, Open Financial system, and rTokens are a first step in this direction.

MakerDAO and the DAI stable currency

The DAI Stablecoin is a currency on the Ethereum blockchain whose value is pegged to the US Dollar. This stable value, unheard of in the cryptocurrency world, is maintained by a clever mix of interest rates and economic incentives.

DAI was built by MakerDAO, but is actually issued by users directly. This ensures the market decides how much money to print, or burn, and reduces reliance on any single actor to decide the money supply.
Let me walk you though how new DAI is minted:

1. Users deposit Ether ($ETH) to the MakerDAO smart contracts
2. Users open a CDP, or Collateralized Debt Position, pledging their Ether as collateral for a loan
3. For each 1.5USD worth of Ether deposited, users can mint up to 1DAI
4. Users are in charge of maintaining their collateral ratio at 1.5x with their loan.
5. If the collateralization ratio isn't enough, the Ether backing a CDP is liquidated.
6. CDPs have a variable interest rate. If DAI is below 1USD, the rate is increased, incentivizing debtors to reduce their DAI positions

So far, DAI has held it's peg quite well, even amongst very strong volatility in the rest of the market. Collateralization is generally much higher than 150% and liquidations are surprisingly rare.

Decentralized Lending protocols

In decentralized lending protocols lenders and borrowers interact directly with eachother through a smart contract.
In order to mitigate risk, borrowers supply collateral for their loans with a value higher than their loan amount.

In pool based money markets, all liquidity is pooled in a smart contract that borrowers take loans from:

• Borrowers deposit Ether and/or other ERC20 tokens to the money market as collateral
• Borrowers take a variable interest loan from the pool of liquidity.
• Lenders(rDAI users, for example) provide liquidity to the pool
• The interest rate paid by the borrowers is credited to the lenders
• The rate is variable and reflects the market, depending on demand for loans and availability of liquidity

How rDAI gets interest

The current rDAI implementation is based on Compound.finance, but we plan to include more markets, like BZX.network and DyDx, in order to always get the best rates for our users, and allow for deeper liquidity.
The main advantage of pool-based protocols as a lender is that money is always liquid, as you don't have to wait for borrowers to pay back their loans. This is possible because these pools build their incentives around always having a certain reserve.When the reserve is very low, interest rates grow, and borrowers rush to close their positions.
As such, rDAI always has a deep pool of reedemable DAI, but of course we can't guarantee liquidity, and redeeming may be limited at times of extreme borrowing. However, collateral is always given for loans, so the backing is never in doubt.