DEFI 101 – Understanding The Basics
Defi which means decentralized finance is a new way to perform financial transactions via applications. It degenerates the system of traditional financial institutions and is conducted over the blockchain. It is like removing brokerages, exchanges and other intermediaries from the equation.
Defi revolves around Decentralized applications which are known as DApps.
It came to a popular graph firstly because of Bitcoin and then speeded and adopted broadly.
Before the transactions were made by a centralized intermediary like the exchange of cryptocurrency or some kind of security exchange on Wall Street. Transactions are directly conducted between participants with the help of smart contract programs.
So the community of developers built and maintained the smart contracts programmed or DeFi protocols, by the use of open-source software.
Defi did the pioneering attempt to decentralized the core of traditional financial use cases like trading, Lending, Investing, Wealth Management, Payment, and Insurances on the blockchain, DeFi thus smartly brought the peer-to-peer financial network.
Some DeFi application promotes high-interest rate but also subjected to the high risk. More than $11 billion worth of cryptocurrency was deposited in DeFi protocols by October 2020 and growth was seen more than 10 times. By January 2021, Around $20.5 billion was invested in DeFi.
The word DeFi is being used around many times. Understanding the core of DeFi is very important in the world of Finance. So, Let’s throw some light over it and know what it is in a very easy way.
- DeFi is actually a short-term for Decentralized Finance.
- DeFi is like a web chain in the financial system which is built on cryptocurrency blockchains, Primarily the Ethereal Blockchain.
- It provides the same service as we commonly call it borrowing, lending, and saving. But the only difference is that they do it in a decentralized pattern where there is no middle man or guarantor in between.
- There is no system of the bank that asks for a part in returns and there is no failure or collapse of a system.
- In Past years, the amount of money Circulated in DeFi has increased almost 10 times to over 7 billion USD.
- They have seen that enormous growth due to a reason. It is because the annual yielding percentage offered by this platform ranges from 2-3% to over 2000% in a very short period of time.
- It directly shows that you can earn a healthy amount of money from these platforms keep the equation of bank aside.
Defi apps and protocols are made using automated smart contracts. Automated smart contracts are used to build these DeFi apps and protocols. Some of them are decentralized autonomous organizations (DAOs) which give users the ability to change it by voting with the token according to their protocols.
They can be broadly categorized as :
- lending protocols
- Decentralized exchanges (DEXs) or decentralized oracles.
- You don’t need to register your identity for lending protocols like Compound and Aave that allows you to borrow cryptocurrency.
- Its protocol says that you cannot borrow money more than you deposit Money.
- They also let participants withdraw the extra cryptocurrency for the trade.
- Their Interest rates vary on what you withdraw especially the Demand and Supply for those assets present in the platform.
Some of the Aggregators like Yearn Finance switch the deposited cryptocurrency between DeFi protocols to provide the investors with the highest possible APY. This Happens with the automated process. Such Apps has drawn huge attention toward a crypto space because they have made the financial transaction much easy and simpler and also taken an intuitive way of interaction with the users in the platform itself which doesn’t put a burden at all to learn how to use for the users because of such reason it has gained and inclined the user’s attention more rapidly toward them as they offer a very simple way of interaction.
Uniswap and Kyber Networks are some Decentralized exchange which also provides similar services as a classical cryptocurrency exchange with one basic difference that they have no point of failure. They keep the funds more secure as they are not held by a centralized third party. DEXs provide a Liquidity mining scheme that rewards the users for depositing funds. They ensure high liquidity in their platform to give users for accessible without getting frustrated. These platforms reward users from the trading fee which ranges from 0.1-0.3% most of the time.
Thus DeFi or Decentralized finance brings a new way to execute financial transactions through applications. It gets conducted over the blockchain by cutting out the traditional financial institutions and intermediaries and provides an easy way to the users.
It is claimed by Purists that DeFi may not have any centralized control rather it works autonomously on blockchains by using smart contracts.
Self Direct Contracts When Some Outcomes Come As to Fruition
“In reality, however, DeFi has become the general term for any application or business that uses blockchain technology or cryptocurrency to create alternative financial products,” stated Roper.
Excluding the mediator, for example, can cause extra expenses, takes unnecessary time and delays or reverse the transactions, or sometimes even makes the client lose everything they invested just like in bankruptcy or fraud. That makes key benefits for DeFi.
This can make traditional financial transactions to be processed in an unconventional way..
With the help of DeFi, we can use, insurance, loans, direct purchases, derivatives, and so on.
DeFi offers many ways to make money, similar to traditional financial transactions. Yield farming is the most common strategy that makes DeFi unique.
“As DeFi has matured and made a good growth new investment tools have risen such as yield farming, which switches your investments between different lending and liquidity pools so you’re always earning the best rates possible,” Roper says.
Yield farming switches your capital between account to increase and maximize to earn the interest at much higher rates.
A liquidity pool is a method used by decentralized exchanges, where the users deposit an equal value of two different kinds of cryptocurrencies or stablecoins, ensuring enough supply for the exchange. In exchange for providing liquidity, the users who deposit currencies in the pool share a reward same in proportion to the stake in the pool.
There are many more traditional and conventional lending services available in the world of DeFi
Even if the concept of DeFi is appealing, there are many risks for the new users. These defects are generally ignored.
“Power and control rest with you, the user. There is generally no ‘central authority’ to go to for help or customer service. If you lose your password or damage your computer, you’re out of luck. It’s imperative that you develop a strong contingency plan for using, storing, and backing up your account information,” stated head of financial relations(IOTA Foundation) Dan Simerman, IOTA is a nonprofit organization that works towards building a network protocol dedicated to the Internet of Things. In the world of cryptocurrency, getting blocked by a pocket or wallet can mean losing your entire investment.”
On top of that, the level of volatility in some of these prominent DeFi strategies can be “unlike anything you’ve ever experienced,” stated Simerman.
It is the most important curious investors to know about DeFi in this day and age: It’s a vast, rapidly evolving field with a lot of uncertainties and technology. It’s not wise to jump into the field without knowing the concept of it.
DeFi one day will spread like the Internet nowadays and will become secure and very dependable so that it can be used by many people every day which is still have coming in the way.
It will have millions of users. DeFi, which got onto the scene in 2020, has only become more relevant in 2021.
Future Of DeFi
DeFi may not be perfect for every person but the services provided by DeFi look promising. The crypto enthusiasts can try to learn about DeFi to earn money from the investment they make in the future.
So, now we have learned many things related to Defi or Decentralized finance. How it provides the most profitable services to its users and how beneficial it can be to invest money in this. As no Bank is interrupting in between it makes work hassle-free to the users. They provide profitable services automatically to the users. It also interacts well with the users and there is no difficulty in any issues. It turns the investments in cryptocurrency and provides the highest-earning profits,
Investors say it will get a higher in demands by the people in upcoming days just like the Internet these days.