Michaël van de Poppe - 23 March 2022
DeFi: the possible future of finance
There is so much to understand when you first begin crypto trading. Within this growing cryptocurrency space, you will find DeFi. DeFi is a subcategory within the crypto world. Some things might sound familiar while others take a longer time to understand. This blog piece will take a deeper look in understanding what DeFi is, where it stands in the crypto world and how it works
As explained earlier, DeFi is a subcategory within the crypto world. DeFi is a word for decentralizing certain financial services. DeFi uses the blockchain and smart contracts to facilitate a dozen of financial services in a decentralized manner, cutting out the middle man. Some examples would be decentralized trading and lending. The blockchain doesn’t consist of a central part so it allows peer to peer, granting access for anyone.
The DeFi space combines a myriad of non-protective financial products created around highly-experimental crypto projects. These projects attract a large sum of capital due to the high yields compared to the traditional finance world. DeFi is currently locking 100bln worth of digital assets.
DeFi vs Traditional financial service providers
What of the main ideas for the creation of DeFi is to challenge or maybe even replace the traditional finance system. The power to allow the people to control it with its open-source code gives more freedom. The traditional way gives financial institutions power over people’s funds while DeFi gives the person control over their own finance.
DEXs (Decentralized exchanges) is an element of the DeFi sector that offers participants to buy and sell digital assets without creating an account on an exchange. In other words, there isn’t any need for a third-party service provider. DEXs’ technology is developed on the compatibility of the blockchains they are built on. They also require having compatible crypto wallets.
Yield aggregators are asset management platforms that move users’ crypto assets between various yield-farming platforms to generate the highest returns.
How it’s used
One of the main importance of understanding DeFi is knowing how it’s used. We will go through some of the key uses of DeFi.
Two of the most popular activities in DeFi are lending and borrowing. Due to the smart ecosystem in DeFi, the lending protocol allows users to use their own cryptocurrency as collateral while borrowing funds.
For DeFi to work and not fall out of value stablecoins make an entrance. They bring stability to lending and borrowing. Stablecoins are normally fixed to fiat currencies which allows them to not collapse.
Components such as margin and leverage allow users to borrow cryptocurrencies on margin. The smart contracts can be programmed to include leverage to give users an increase in returns. The only biggest issue with that is it increases risk exposure to the user as there is no human component in a system based on algorithms.
To wrap up the topic on Defi we now understand that it is a subcategory within crypto containing all kinds of different financial services hosted on the blockchain without a middleman. Defi gives users total control over their personal finances.
Don’t forget that DeFi is built by code this gives it the possibility to be built on top of each other which is beneficial for the whole market. More capital efficiency and higher yields lead to attracting a large capital sum generating much higher yields than in traditional finance.
Although, we must remember that it is still highly experimental and smart contracts are still coded by humans allowing for errors to be made. Not to forgetting mention that a lot of money is lost due to exploits and hackers. Always be careful when you are investing in new projects.