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3. Advanced Course

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  1. 1. What is Taproot?
  2. 2. Blockchain bridges – what are they?
  3. 3. What is Ethereum Plasma?
  4. 4. What is Ethereum Casper?
  5. 5. What is Zk-SNARK and Zk-STARK? 
  6. 6. What is Selfish Mining? 
  7. 7. What is spoofing in the cryptocurrency market? 
  8. 8. Schnorr signatures - what are they? 
  9. 9. MimbleWimble - what is it? 
  10. 10. What is digital property rights in NFT?
  11. 11. What are ETFs and what role do they play in the cryptocurrency market? 
  12. 12. How to verify a cryptocurrency project – cryptocurrency tokenomics 
  13. 13. What is the 51% attack on blockchain?
  14. 14. What is DAO, and how does it work?
  15. 15. Zero-knowledge proof – a protocol that respects privacy 
  16. 16. What is EOSREX?
  17. 17. What is Proof of Elapsed Time (PoET)?
  18. 18. Mirror Protocol – what it is? 
  19. 19. What are synthetic assets? 
  20. 20. How to create your own NFT? 
  21. 21. Definition of DeFi, and what are its liquidations?
  22. 22. New identity system - Polygon ID
  23. 23. Ethereum Foundation and the Scroll protocol - what is it?
  24. 24. What is Byzantine fault tolerance in blockchain technology?
  25. 25. Scalability of blockchain technology - what is it?
  26. 26. Interchain Security - new Cosmos (ATOM) protocol
  27. 27. Coin Mixing vs. Coin Join - definition, opportunities, and threats
  28. 28. What is Ethereum Virtual Machine (EVM) and how does it work?
  29. 29. Soulbound Tokens - what are they, and how do they work?
  30. 30. Definition of LIDO - what is it?
  31. 31. What are Threshold Signatures, and how do they work?
  32. 32. Blockchain technology and cyberattacks.
  33. 33. Bitcoin script - what it is, and what you should know about it.
  34. 34. What is zkEVM, and what are its basic features?
  35. 35. Do confidential transactions on blockchain exist? What is a Confidential Transaction?
  36. 36. Algorithmic stablecoins - everything you should know about them.
  37. 37. Polygon Zk Rollups ZKP - what should you know about it?
  38. 38. What is Web3 Infura?
  39. 39. Mantle - Ethereum L2 scalability - how does it work?
  40. 40. What is the NEAR Rainbow Bridge?
  41. 41. Liquid Staking Ethereum and LSD tokens. What do you need to know about it?
  42. 42. Top 10 blockchain oracles. How do they work? How do they differ?
  43. 43. What are Web3.js and Ether.js? What are the main differences between them?
  44. 44. What is StarkWare, and recursive validity proofs
  45. 45. Quant Network: scalability of the future
  46. 46. Polygon zkEVM - everything you need to know
  47. 47. What is Optimism (OP), and how do its roll-ups work?
  48. 48. What are RPC nodes, and how do they work?
  49. 49. SEI Network: everything you need to know about the Tier 1 solution for DeFi
  50. 50. Types of Proof-of-Stake Consensus Mechanisms: DPoS, LPoS and BPoS
  51. 51. Bedrock: the epileptic curve that ensures security!
  52. 52. What is Tendermint, and how does it work?
  53. 53. Pantos: how to solve the problem of token transfer between blockchains?
  54. 54. What is asymmetric encryption?
  55. 55. Base-58 Function in Cryptocurrencies
  56. 56. What Is the Nostr Protocol and How Does It Work?
  57. 57. What Is the XDAI Bridge and How Does It Work?
  58. 58. Solidity vs. Rust: What Are the Differences Between These Programming Languages?
  59. 59. What Is a Real-Time Operating System (RTOS)?
  60. 60. What Is the Ethereum Rinkeby Testnet and How Does It Work?
  61. 61. What Is Probabilistic Encryption?
  62. 62. What is a Pinata in Web 3? We explain!
  63. 63. What Is EIP-4337? Will Ethereum Account Abstraction Change Web3 Forever?
  64. 64. What are smart contract audits? Which companies are involved?
  65. 65. How does the AirGapped wallet work?
  66. 66. What is proto-danksharding (EIP-4844) on Ethereum?
  67. 67. What is decentralised storage and how does it work?
  68. 68. How to Recover Cryptocurrencies Sent to the Wrong Address or Network: A Practical Guide
  69. 69. MPC Wallet and Multilateral Computing: Innovative Technology for Privacy and Security
  70. 70. Threshold signature in cryptography: an advanced signing technique!
  71. 71. Vanity address in cryptocurrencies: what is it and what are its characteristics?
  72. 72. Reentrancy Attack on smart contracts: a threat to blockchain security!
  73. 73. Slither: a static analyser for smart contracts!
  74. 74. Sandwich Attack at DeFi: explanation and risks!
  75. 75. Blockchain RPC for Web3: A key technology in the world of decentralized finance!
  76. 76. Re-staking: the benefits of re-posting in staking!
  77. 77. Base: Evolving cryptocurrency transactions with a tier-2 solution from Coinbase
  78. 78. IPFS: A new era of decentralized data storage
Lesson 21 of 78
In Progress

21. Definition of DeFi, and what are its liquidations?

DeFi, like loan protocols, is a new and interesting option for people who do not really want to keep funds in the bank. As investors, we get access to an entirely new way of borrowing. At the same time, we can earn more from our cryptocurrencies. However, this carries a certain risk, more precisely – liquidations.

What are they, how do they work in the DeFi ecosystem and how to manage risk in such a situation – this is what we will deal with today.

Definition of DeFi and a reminder of how it works

Decentralized finance (DeFi) are financial applications, built on blockchain technology. They allow users to make transactions without intermediaries (banks or other financial institutions). Arrangement (transaction) is done via smart contracts.

DeFi projects include:

DEX’y, that is decentralized cryptocurrency exchanges. They allow transactions to be made directly between user A and B. The most popular DEX is UNISWAP.

Different kinds of lending platforms that enable users to take out loans. This group includes Aave, Compound and Maker.

Loan ecosystems, synthetic assets. This group includes Synthetics and Fulcrum.

Oracles responsible for transmitting information from the outside world to the ecosystem blockchain. They are essential for the operation of any protocol DeFi. A leader, as I’m sure you know, is Chainlink. We wrote more about it here.

Stablecoins worth mentioning. At the same time, you must remember that they are on the verge of DeFi. Stablecoins are the so-called stable cryptocurrencies that reflect the value of a given fiat currency – USDT, BUSD or DAI.

You are a diligent student, so from our previous lessons you know how the protocols work in decentralized finance. Nevertheless, to understand what liquidations are, we will briefly recall the basic assumptions of loans in DeFi.

As a borrower, you list yours cryptocurrencies as collateral for the loan. Given the volatility of digital assets, your collateral can also change in value. Then, the chance that the loan will be liquidated, and you will lose your collateral is much, much higher.

This is how liquidations work, DeFi. This carries a massive risk for the borrower. So, it’s worth knowing how to use lending protocols wisely in the decentralized finance space.

The problem of liquidation and loans – explanation

Assumption loans are simple. You need a certain amount of money to give back later. In addition, you pay interest to the person who lent it to you – you give him collateral. It provides the lender with a way to recover your funds when you are unable to make repayments. Using collateral against your debts is called Liquidation

Liquidations in DeFi are a similar process. Then the smart contract sells your cryptocurrency collateral to cover your debt. However, they are more insidious than loans in traditional finance. Why?

As we mentioned – for volatility, cryptocurrency values. The collateral you provide may change overnight and be useless to cover your losses. Which is why smart contracts that govern loan protocols contain an additional condition. Example:

We take out a loan in DeFi. We give X bitcoins as collateral. If the value of our BTC collateral falls below the liquidation threshold, the protocol will automatically liquidate our loan by selling our collateral. It doesn’t matter that, for example, we have repaid most of it. The protocol will want to recoup its costs before the value of bitcoins drops even more and can’t cover our debt.

The same process occurs in the case of Ethereum or other cryptocurrencies

Whim of the market? Some. Taking a loan in DeFi, you must bear in mind that your security may not return. It doesn’t matter how much of the loan you have repaid.

It is also not that loan protocols transfer all responsibility to the borrower. Furthermore, it’s also a risk for them. If the loan is liquidated, the protocol is left with collateral that no one will want to buy. Thus, the protocol will not recover the loan. Therefore, to make a quick sale, smart contracts sell our collateral discounted.

Liquidation risk – can we avoid it?

Considering the volatility of the value, cryptocurrencies, so will our security. We have to use common sense between security and quantity of cryptocurrencies that we borrow. You can always increase the value of the deposit you deposit.

DeFi is an ecosystem with its own rules and risks. Before you start navigating it in the protocol, understand how it works and how they work smart contracts. Education above all. We have already discussed this topic in our lessons.

Trivia

  1. Liquidation is often associated with stop loss for borrowers
  2. The liquidation threshold protects the lender from falling prices.
  3. DeFi platforms offer liquidation bonuses for liquidators.
  4. Liquidators deal with the purchase of discounted collateral and cover the debt on the account.
  5. Liquidators often work with bots to liquidate loans even faster and earn bonuses.

Summary

Another step forward! You already know what they are liquidations in DeFi – congratulations. We invite you to follow the next lessons in our series.