The concept of decentralized finance or DeFi is one of cryptocurrency’s best selling points. But what is DeFi and what exactly does it entail?
What is DeFi in Cryptocurrency?
Decentralized finance (DeFi) is an all-encompassing term that refers to financial services and technology built on and carried out on public blockchains.
Using Defi, you can do essentially everything banks offer such as buying insurance, earning interest, trading assets, lending and borrowing. All of this is done faster and with considerably less paperwork than centralized finance.
Defi is peer-to-peer, pseudonymous, global and open to all; same as cryptocurrency. The whole system is set up to lessen the control banks and other financial institutions have on financial services, products and money as a whole.
How does DeFi work?
Decentralized finance uses blockchain technology. A blockchain is a secured and distributed database. The blockchain (and transactions in it) is run by software applications known as dApps(“decentralized apps”). Transactions in the blockchain are recorded in blocks and confirmed by other users. Once the verifying parties agree on the validity of a transaction, the block is closed and encrypted; then a new block is created. This new block will contain the information about the preceding block.
All the blocks are linked together through the information stored in each previous block. It is impossible to make changes to the blockchain because the information held in preceding blocks cannot be changed without affecting other blocks. This arrangement alongside other security protocols lays the foundation for the safety of a blockchain.
How to use DeFi
Presently, users interact with DeFi through decentralized apps that run mostly on the Ethereum blockchain. However, with the growing popularity of DeFi, newer blockchains such as Avalanche, Binance Smart Chain, Cardano, Polygon, Solana e.t.c, currently also support the development of DeFi projects.
Unlike engaging with a traditional banking institution, users do not have to fill out an application or go through many strenuous processes. These are some ways you can use Defi:
- You can get loans almost instantly without needing to fill mountains of paperwork.
- You can lend crypto to interested parties and earn interest rewards by the minute rather than monthly (as offered by centralized finance).
- You can save your crypto in a DeFi savings account to earn higher interest rates than a bank would provide.
- You can carry out p2p (peer-to-peer) trading of crypto assets just like buying and selling stocks in the fiat exchange market.
How to Invest in DeFi
Once you have a basic understanding of what is defi and ways you can use decentralized finance as an everyday user, you can now move to defi investments.
Here are some ways to get started:
There are several trusts and funds in the DeFi ecosystem such as Grayscale’s Diversified DeFi fund and Bitwise’s DeFi Index. Investing in these funds is one of the easiest ways for a beginner to get into the world of decentralized finance.
Staking involves holding or locking your funds in a crypto wallet in order to join in maintaining the processes of a proof-of-stake (PoS) based blockchain system. As compensation for staking, these users received a pre-stated interest rate. A great reason to get into defi staking is the fairly considerable interest rate, particularly when you look at other interest rates on the market. Presently, DeFi has a total value locked (TVL) of $100 billion USD on Ethereum alone.
DeFi Yield Farming
Yield farming involves providing crypto assets which serve as liquidity to a decentralized exchange (DEX). This exchange utilizes the liquidity to implement orders made by token swappers (who pay fees). Yield farmers earn a percentage of these fees as remuneration for their crypto asset contribution. The sharing of rewards are typically done using an automated market maker (AMM) protocol that carries out the transactions.
Decentralized finance is still fairly new and developing. Thus, there are issues to consider before trying your hands at DeFi investing. For instance, active trading can be quite expensive due to the constantly changing transaction rates on the Ethereum blockchain. Also, depending on how and which dApps you used, you may face high volatility on your investments. In addition, there is risk of fraud and security challenges due to the vulnerabilities of smart contracts used to run DeFi protocols.
Nonetheless, the range of DeFi investment opportunities together with the consistent market growth makes a solid case for positioning DeFi as a potentially rewarding venture to participate in. As long as you stay aware of the risks and keep track of the regulations that are sure to come in due time, investing in DeFi is worth the shot.
Disclaimer: this article was written by the writer to provide guidance and understanding of cryptocurrency trading. It is not an exhaustive list and should not be taken as financial advice. Obiex Finance will not be held liable for your investment decisions.