Smart contracts: Providing cheap liquidity and risk reduction using DeFi

In years past till now, contracts have always existed to ensure that parties perform their promised obligations as stipulated in the terms in exchange for something of value referred to as consideration. The contracts can be made orally or written.

The purpose for the existence of contracts is to ensure that the interests of parties are protected by law and that both parties commit to fulfil their obligations as promised. Failure to adhere to terms stipulated therein, will result to remedies or compensation.

With the advent of blockchain technology, smart contracts have opened up a whole new way of creating and executing transactions in commerce while mitigating the risks involved in non-performance as well as providing liquidity to deficit units of the economic agents. This new applications in finance using blockchain technologies and cryptocurrencies open to anyone for usage by removing intermediaries like financial institutions is termed as DeFi(Decentralized Finance). DeFi is expected to take over and replace the old financial systems.

What are smart contracts

Smart contracts are written self-executing code that is able to make financial decisions without manual interventions on the blockchain. 

The Ethereum blockchain provides a platform for creating and executing most smart contracts, smart contracts eliminate the corrupt practices, time lapse and high fees often associated with traditional contracts done on paper and ink. It provides a trusted authority to enforce contracts as they were agreed upon. With the blockchain acting as an intermediary and enforcer of the contract.

implementing smart contracts helps to eliminate some risks associated with traditional contracts. However, due to its new form. The blockchain also faces some risk which is a matter for later discussion.

Smart contracts eliminate risk in the following way:

1. It prevents payments for uncompleted milestones
2. It can automatically offer financial compensation for non-performance
3. Prevents time delay in business transactions where time is of essence
4. Reduces transaction cost to a negligible amount

How does smart contracts access liquidity

smart contracts can communicate with open source money market protocol or liquidity pools that resides on the Ethereum blockchain. It enables users to earn interest on crypto assets and borrow crypto assets with or without collateral. All this comes with as little costs as possible compared to the ones offered by centralized financial institutions

Every one can access to liquidity providers that reside on the blockchain by simply connecting a crypto wallet on their interface. However, when using smart contracts to access liquidity, you will need a developer to integrate and code the smart contracts that can interact with the various liquidity providers before you can communicate on the Ethereum blockchain. The liquidity providers have their own rules and protocols on how to access the pool of resources. These liquidity providers add liquidity to the pool to create a market. In exchange for providing their funds, they earn fees from the transactions, proportional to their share of the total liquidity.

Aave, Uniswap, dydx are examples of the decentralized exchange that provide you access to liquidity in the form of products such as flash loans, loans and interest earnings on deposits with or without collateral. Programming a smart contract to access these products will give you access to huge liquidity available on the blockchain. The strategy involved in using crypto assets to earn more crypto assets and maximize returns through the use of smart contracts is known as Yield farming.

Conclusion