As the world we live in today continues to grow and embrace digital innovations, traditional institutions are posed with the challenge to keep up with the advancements in technology.
The rise in popularity of crypocurrencies, for example, has attracted people to be more attuned to their finances. Many years ago, if someone told you that you can grow your finances exponentially online, people wouldn't believe you. But nowadays, anything is possible.
Before you get ahead of yourself and commit to DeFi, it's best to know what you're getting yourself into. Whether you're new or a veteran when it comes to financial innovations, this guide is for to gain an introduction to DeFi or "Decentralized Finance".
How to DeFi
"How to DeFi" written by Darren Lau, Teh Sze Jin, Kristian Kho, Erina Azmi, TM Lee, Bobby Ong is an excellent resource to get the best introduction to DeFi and the DeFi space. "How to DeFi" was reviewd by experts like Jocelyn Chang APAC Growth Lead of MakerDAO Grwoth Core Unit. Mariano Conti, Head of Smart Contracts at Maker Foundation Decentralized Finance, even called this book "The best introduction you could ask for."
In this article, we will be summarizing the key components of How to DeFi.
What is DeFi?
DeFi or "Decentralized Finance" is one the latest innovations disrupting the traditional financial industry today. It uses the same secure distribution ledgers, similar to what cryptocurrencies use. The term "decentralized" would mean that there is no singular entity that has the power to control financial services. This implies an open finance system where you have control and visibility of your transactions. Not only that, but it allows you to have access to global markets and other financial solutions like alternatives to your local currency and multiple banking options.
How does DeFi differ from Traditional Financial Institutions?
DeFi employs a "decentralized" ecosystem where there is no singular entity governing over one's financial services.
This differs from the traditional financial sector, like banks, because there is an authorized figure who'll have to approve financial services. Setting up a bank account, for example, banks would need you to send in documentary requirements and a minimum monetary deposit in order to be approved to have a bank account. More or less the same process follows to set up a loan.
In "centralized" finance, there needs to be an entity that approves of any financial transaction you'd wish to do. With that, there are multiple steps one would have to take before even making a transaction. Not only can it take time to have these things authorized, but it may even cost additional fees.
How does DeFi challenge traditional finance?
Apart from the multiple steps needed to authorize financial services in traditional banks, there are other factors that contribute to how centralized finance is a bit outdated.
prone to Human-related risks
Since traditional banks relies on entities to govern and authorize financial services, it is prone to human-related risks such as mismanagement and corruption. Unlike in DeFi, where your digital assets are handled by blockchain technology which cannot be tampered with.
no more Additional Expenses
Since there are intermediaries involved, transferring money, for example, can cause merit additional expenses with crazy interest rates applied. Payment processing may even take time to have the transaction approves, especially if you're in another country. DeFi eliminates the need for additional steps in payment processing, since it DeFi services can be done by anyone and its reflected in real-time.
ACCESSIBLE FINANCE for all
One of the biggest challenges banks have against financial innovations like crypto and DeFi is how accessible it is for all, especially in market capitalization. Since DeFi can be accessed by anyone with a mobile phone and internet connection, it opens DeFi to the unbanked market, who may involve people who find traditional banking and its services as inconvenient. DeFi makes it possible to provide financial services to all regardless of where you live, how much you make, and other hindrances.
Because DeFi uses blockchain technology, decentralized exchanges are visible for all as it is open-source. Blockchain technology is secure as there are rules in code, making it less prone to human error and difficult to tamper with. Because of its visibility, you know exactly where your money will go and in turn, you can see the money in the market flows through DeFi applications.
Decentralized Finance aims to address these concerns through these key points:
Using the latest digital innovations to their advantage
Making financial instruments and services more accessible to all.
The Goal of DeFi
DeFi challenges the traditional financial sector and aims to eventually replace it as a financial service provider. The ultimate goal would be to give users greater control over their funds, whereas traditional banks have the goal to make more money for their institutions.
How does Decentralized Finance (DeFi) work?
To better grasp the many factors that interact with each other in DeFi, "How to DeFi" discusses key proponents of DeFi in a very interesting constant comparison with real-life scenarios. Key categories include the following:
Decentralized finance DeFi works through an ecosystem of Decentralized Applications, called Dapps. DeFi Dapps provide financial services built on top of distributed networks with no governing authority. It's not just a single company, but DeFi is comprised of different protocols and applications that enable financial services. How decentralized applications work is through interacting with blockchain through the use of smart contracts.
What are the Advantages of Dapps?
DeFi Dapps are immutable. Since it uses blockchain tech, which is an immutable ledger used to record and monitor financial transactions, you cannot change information once its in the blockchain. With that, it also makes it merely impossible to tamper with the blockchain, unless it affects everyone on the network. Because DeFi and in turn, Dapps are open-source, anyone and everyone can access it. Dapps also make sure of the latest digital innovations and as long as there is Ethereum, for example, the social contract will still work.
What are the disadvantages of Dapps?
While Dapps can be beneficial, there are some things one must be mindful of. Because of the transparency of DeFi, should you make a mistake in the crypto space, it may escalate to bigger issues. Since DeFi is open source and everyone has access to it, you have to be wary of what you expose since it could be exploited. In addition, since Dapps are tied to blockchain, if there are limits with blockchain, that will reflect accordingly with Dapps.
The Decentralized Layer
Usually, Dapps and Ethereum come hand-in-hand. Not only is this because Ethereum is a global and open-source platform for Dapps, but also because many developers deploy their Dapps on Ethereum due to its compatability. What developers do is they write a smart contract with a particular code/set of rules and make this social contract accessible to anyone in the world through the Ethereum platform. As previously mentioned, Dapps are reliant on Ethereum as long as Ethereum is up and runnings, the same follows for Dapps.
Apart from serving as a platform for Dapps, Ethereum can be used to create decentralized autonomous organizations or DAOs and even create other cryptocurrencies. These autonomous organizations are decentralized, meaning they aren't governed by a single entity, and are enforced using code.
Smart contracts are programs running on a blockchain between two parties, which would execute a particular action once certain conditions have been met. These smart contracts do not require an intermediary, and multiple smart contracts can be stacked together to execute complex operations.
Much like any financial transaction, Ethereum also has a currency called Ether (ETH). This is the native currency of the Ethereum blockchain which can be used to run smart contracts.
To run the Ethereum platform, one would need to pay a fee called "gas" to execute a smart contract. With any market, a resource's price would fluctuate depending on its supply and demand. It follows that there would be high gas fees given the overall rise of popularity in the crypto space.
What are the use cases of DeFi?
"How to DeFi" outlines several use cases for DeFi particularly:
Stablecoins are types of cryptocurrencies that are less volatile because these are coins based on stable assets/currencies, making it a more reliable medium of exchange. Decentralized stablecoins can either be fiat-collateralized (e.g. USDT) or crypto-collateralized (e.g. DAI)
Decentralized Lending & Borrowing
Because financial services are more accessible, regardless of whether you have a bank account or not, decentralized lending and borrowing are more feasible for more markets. Everyone has the opportunity to contribute to the decentralized liquidity pool of funds (and even earn interest on it) which borrowers can easily use.
DeFi makes exchanges possible since there is no authorizing entity needed. These exchanges are secure through the use of smart contracts, where operations can be carried out without the need for an intermediary.
One financial innovation available in DeFi is the use of decentralized derivatives where value is tied to another asset. These assets can be in the form of stocks, commodities, currencies, indexes, bonds or even interest rates.
Decentralized Fund Management
Through DeFi applications, there are other ways to get more money passively. Decentralized Fund Management helps you monitor and manage your assets to your advantage. Dapps and using a smart contract can be used to carry out trades and generate a return on your investments for you automatically.
Decentralized lotteries give people an opportunity to pool money to accumulate interest. How this works is that people pool together money for a change for one person to get all the interest. What makes it different from a typical lottery is that at the end of the lottery, people are able to keep their initial deposit and these are refunded to them. The decentralized lottery is more secure since it is backed by smart contracts and blockchain tech, without needing an overseeing authority.
Through DeFi and its accessibility, users can pay when you need it. Since it is decentralized, you won't be subject to any hindrances like transfer fees or long payment processing wait times. You can use the decentralized payment to your advantage by timing your transfers, conducting payment under certain conditions, all with the benefit of cheaper and faster transactions.
Decentralized Insurance & Governance
Even if DeFi is already secure through blockchain, it still provides decentralized insurance to protect you when you engage in financial services. DeFi also gives out governance tokens to people, giving them power and authority on the DeFI ecosystem.
How to Understand DeFi
With everything said, there's no denying that decentralised finance is the way to go in a generation of bankless pioneers and new economies created. DeFi paves the way for redefining finance by challenging traditional finance through its accessibility. Here's how to DeFi:
Set up your wallet
You can access DeFi by creating a wallet that supports dapps. Since most protocols live on Ethereum, it's recommended that your crypto wallet be compatible with that.
Applications like Binance, Coinbase, Metamask and Keplr are Ethereum-compatible wallets where you can receive, store and send out crypocurrencies. This also holds your private keys for safekeeping. You can choose to either have a custodial wallet where third-parties can maintain control over your crypocurrencies (such as Binance and Coinbase) or a non-custodial wallet where you have total ownership of your cryptocurrencies (such as Metamask and Keplr).
explore defi yourself
Now that you have a wallet set up, the next best way to understand DeFi is by exploring the DeFi space yourself. By moving funds around through a blockchain, you can see firsthand how DeFi protocols work. For example, you can engage in yield farming, where you become a "yield farmer" that involves earning tokens that are awarded for lending out your cryptocurrencies. You can even purchase coins relevant to the DeFi protocol you plan on using or invest in decentralized exchange.
EXPLORE OTHER DEFI RESOURCES
Seeing that the DeFi ecosystem is relatively new, there are so many things we have yet to learn about when it comes to decentralized finance (DeFi). Because of that, it's best to diversify your resources in learning more about what it is. Reading DeFi books like "How to DeFi" for example, serves as step by step guides in providing a comprehensive introduction on the DeFi. In this case, the book details concise explanations and a technical analysis on the many novel financial innovations enabled by DeFi protocols.
In this digital age and generation, learning the DeFi ecosystem is essential if you want to keep up with the evolving financial industry. Decentralized finance will continue to challenge the traditional financial sector by directly addressing the many issues users face with banks and its services. Through DeFi, additional fees and processes are eliminated since everything can be done directly. DeFi users uses dapps and smart contracts to streamline financial transactions. Most importantly, DeFi is one step closer to fulfilling Ethereum's lofty vision of replacing traditional finance service providers.Although DeFi proves to be greatly beneficial, if any new innovation, it's important to do more research in order to understand its risks.