• Abdullah Mohsin

Introduction to DeFi

What is DeFi?

Short for decentralized finance, DeFi is a broad category for peer-to-peer (meaning directly between two people, not through a centralized system) financial services on public blockchains, primarily Ethereum but with time more chains have emerged such as Binance Chain (BNB) and Solana (SOL) to name a few. 

DeFi is an example of blockchain-based financial software that provides several ways for creating financial services, it is decentralized, and has the flexibility to change as necessary.

  • With DeFi, you can do most of the things that banks support like earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and more but it’s faster and doesn’t require paperwork or a third party.

Why is DeFi important?

DeFi takes the basic idea of Bitcoin and Crypto (digital money) and expands on it, creating an entire digital alternative to Wall Street, but without all the costs (like office towers, trading floors, banker salaries and more). This has the potential to create more open, free, and fair financial markets that are accessible to anyone with an internet connection.

How does it work?

Users typically engage with DeFi via software called Dapps (“decentralized apps”), most of which currently run on the Ethereum blockchain. There is no application to fill out or account to open, unlike a traditional bank. The picture above provides a visual representation of DeFi.

Here are some of the ways people use DeFi:

  • Lending: Lend out your crypto and earn interest and rewards every minute not once per month.

  • Getting a loan: Obtain a loan instantly without filling in paperwork, including extremely short-term loans that you cannot get from Banks.

  • Trading: Make peer-to-peer trades of certain crypto assets such as swap Bitcoin for Ethereum directly without any broker.

  • Saving for the future: Put some of your crypto into savings account and earn better interest rates than you’d typically get from a bank. 

What are some of the technologies and Dapps built on DeFi?

  • Decentralized exchanges (DEXs). Right now, most cryptocurrency investors use centralized exchanges like Coinbase or Binance. DEXs facilitate peer-to-peer financial transactions and let users retain control over their money. (Examples include UNISWAP, SUSHISWAP and PANCAKESWAP)

  • E-wallets. DeFi developers are creating digital wallets that can operate without need of the largest cryptocurrency exchanges and give investors access to everything from cryptocurrency to blockchain-based games. (Examples include Metamask and Trust Wallet)

  • Stable coins. While cryptocurrencies are notoriously volatile, stable coins attempt to stabilize their values by tying them to non-cryptocurrencies, like the U.S. dollar which means the token will be always worth 1$ (Examples include DAI)

  • Yield harvesting. Dubbed the “rocket fuel” of crypto, DeFi makes it possible for investors to lend crypto and gain big rewards in return. (Examples include AAVE, COMPOUND and VENUS FINANCE)

  • Non-fungible tokens (NFTs). NFTs create digital assets out of typically non-tradable assets, like videos of sport matches or pictures of Artwork. NFTs allow us to give value to digital assets and also prove ownership.

What are the benefits?

  • Open: You don’t need to apply for anything or “open” an account. You just get access by creating a wallet.

  • Anonymous: You don’t need to provide your name, email address, or any personal information.

  • Flexible: You can move your assets anywhere at any time, without asking for permission, waiting for long transfers to finish, and paying expensive fees.

  • Fast: Interest Rates and rewards often update rapidly (as quickly as every 15 seconds), and can be significantly higher than traditional Wall Street.

  • Transparent: Everyone involved can see the full set of transactions on the blockchain which Banks rarely allow.

What are the downsides? 

  • Fluctuating transaction rates on the Ethereum (or any) blockchain mean that active trading can get expensive.

  • Depending on which dapps you use and how you use them, your investment could experience high volatility this is, after all, new technology.    

  • The Dapp (decentralized app) might be attacked or compromised by hackers if its security is not up to the mark which may cause your funds to be stolen so it’s important to do research and pick safe ones.

The Future of DeFi

An Open Financial system, aka DeFi, has created new ways in which anyone, regardless of their geographical location, economic status or background can grow wealth with interest-bearing accounts, lend or borrow stablecoins, and swap cryptocurrencies or nft’s easily and freely anytime anywhere.

From taking out the middleman in traditional finance to turning paintings and drawings into digital assets with monetary value, DeFi’s future looks very bright. The number of DeFi projects is increasing every week and more investors are becoming interested in DeFi. However, this is all just the beginning for DeFi and there is much more growth and improvements to come. 

To summarize it very shortly, DeFi takes away centralization in financial or trading systems and allows anyone to freely take control of their own assets and use them as they like thanks to the blockchain and coding. 

Useful links:

  1. AAVE: https://aave.com

  2. Uniswap: https://uniswap.org

  3. Sushiswap: https://sushi.com

  4. Pancakeswap: https://pancakeswap.finance

  5. Compound: https://compound.finance

  6. Venus: https://venus.io

  7. Metamask: https://metamask.io

  8. Trust Wallet: https://trustwallet.com

  9. Opensea: https://opensea.io

Please note none of the above are financial advice, always do your own research.

Common Defi terms:

  • DEX: Decentralized exchange, one that is not controlled by a company and relies on user provided liquidity

  • DAPP: Decentralized apps, applications built on blockchain with no central owners, usually governed by DAO’s 

  • Yield: The rewards that you are getting, for example providing USDC loans to AAVE will yield 2% annually 

  • DAO: Distributed Autonomous Organization. Can be defined as an ‘organisation’ on a blockchain, represented by a set of rules encoded as a computer program (on a blockchain) that is transparent, controlled by the organization members and not influenced by a central government.

  • Liquidity: Liquidity measures the circulating supply and how much trading activity there in an exchange, economy, or network. A currency with low supply and/or circulation is said to be illiquid

  • TVL/TLV: The Total Value Locked (TVL), sometimes also called Total Locked Value (TLV) is a measure of the dollar value of all the investor deposits in coins or tokens locked into a platform, protocol, lending program, yield farming program, or insurance liquidity pool.

  • Automated Market Maker (AMM): A decentralized asset trading pool that enables market participants to buy or sell cryptocurrencies. Uniswap is the most well-known AMM.

5 views0 comments

Recent Posts

See All

What is Ethereum? Ethereum is a decentralized computing platform. You can think of it like a laptop or PC, but it doesn't run on a single device. Instead, it simultaneously runs on thousands of machin

What are Smart Contracts? Nick Szabo first described smart contracts in the 1990s. Back then, he defined a smart contract as a tool that formalizes and secures computer networks by combining protocols

What is GameFi GameFi is a fusion of the words game and finance. It refers to play-to-earn blockchain games that offer economic incentives to players. The GameFi ecosystem uses cryptocurrencies, non-f