Beginners Guide For DeFi
DeFi (decentralized finance) aspires to create a financial system independent of governments and central banks. All you need is a smartphone and an internet connection to open a bank account and send money over the globe. This article will discuss what DeFi is, how it works, its application, cons, and its future.
What is DeFi?
The term “DeFi” is a broad category that can refer to a wide variety of complex financial instruments that operate entirely on the internet and do not need the participation of any third parties. All transactions on the blockchain confirmed are referred to as “open finance,” and this characteristic makes the blockchain an open system. The demise of fidelity lays the stage for social instability. Millions of people throughout the globe may soon have access to financial services that do not need the involvement of third-party legacy institutions.
How Does DeFi Work?
Because it is such a broad notion, decentralized finance encompasses more than just cryptocurrency. The purpose of DeFi’s smart contracts is to serve as a replacement for the existing monetary system. Decentralized financial applications do not use banks or other financial organizations since there are no intermediaries to facilitate transactions. Because anybody can see the source code for DeFi protocols, they are known for their transparency. When accessing open networks, national boundaries are not users’ fundamental obstacle. Several applications geared toward end users are built on the Ethereum network.
Applications of DeFi’s
One way to think about a typical bank is in terms of the way it functions. Buying insurance, rapidly obtaining a loan, storing bitcoin, and exchanging currencies are some of the standard banking services that DeFi provides as an alternative to traditional banking services (in this case, instantaneously swapping tokens). In the “real world,” applications of DeFi might take many different forms.
1. Stablecoins
One of the most common applications for cryptocurrencies is as a kind of cash or a store of wealth. If you want to stay liquid and minimize price swings as much as possible, there is a lot of volatility in the crypto market. Having a stable currency might assist.
Stablecoins retain their value because another financial asset backs them. As a result, we now have stablecoins such as TUSD backed by actual cash. Stable currencies, like MakerDao’s DAI, may be backed by another cryptocurrency. Algorithmic stablecoins like UST are also available. Due to their inherent stability, lenders and investors choose stablecoins for use as collateral and a store of wealth.
2. Decentralized Exchanges
Exchanges for cryptocurrencies make it possible to buy and sell digital currencies like bitcoin. The process of converting Bitcoin to USDT or Solana to Ethereum has been much simplified. Binance, Kucoin, and Coinbase are now the most widely used cryptocurrency exchanges. Much like the previous financial system, these exchanges are plagued by centralization and the accompanying concentration of power. They become relevant when decentralized exchanges are taking place. Users of these platforms can buy, sell, and manage their own money without the intervention of a third party while using the platform’s features. It is more difficult to exert control over the price of bitcoin since no one institution is in charge of the assets. Common DEX types are Opensea, Uniswap, and Pancakeseal.
3. Lending and Borrowing
Think about going to a regular bank, filling out the loan application, and waiting for days or weeks for the loan officer to decide whether or not you qualify for the loan. Because no middlemen are involved, there is no longer any need to wait for a loan with DeFi (loan officers and banks).
You might generate an income from your cryptocurrency holdings by employing DeFi protocols such as Compound, Aave, Solend, or Oasis Borrow to make bitcoin loans. You may get a loan against your digital money at a predetermined rate with a very low-interest rate, and the whole process takes just a few clicks.
4. DeFi Insurance
It is challenging to think of a service that is not provided by traditional finance that DeFi does not also provide. When it comes to decentralized plans, traditional insurance ideas are just as applicable. It acts as a kind of cryptographic insurance against unanticipated events. It is possible to prevent problems like hacking of wallets and exchanges, instability problems with stablecoins, failures of smart contracts, and other problems with adequate security precautions.
In the same way, as you would with conventional financing, you must pay a premium to a DeFi Insurer to get protection against unanticipated risk. In contrast to more traditional financing forms, the premiums paid here are placed in a capital pool provided by insurance companies (insurance companies). Examples of such businesses are Insure Defi, Bridge Mutual, and Nexus Mutual Insurance Company. Other examples include many more.
5. Yield Farming
The yield farming application developed by DeFi is cutting edge and might benefit your portfolio. Investors in cryptocurrencies make use of this strategy to increase their overall profits. Your savings account will be credited with the bonus amount. For example, Aave and Curve Finance will provide you with cryptocurrencies as a thank-you for keeping other tokens in your possession for an extended period.
Cons of Using DeFi
The following are the downsides of DeFi:
● Expansion Issues
Because smart contracts for DeFi are built on the Ethereum network, this might potentially have a negative impact. The Ethereum network has been plagued by its inability to scale. Every day, the Ethereum blockchain executes between one million and 1.5 million transactions, equating to thirteen to seventeen transactions being processed every second.
● Excessive Gas Fees
There is a negative correlation between the number of users on the Ethereum blockchain and the number of transactions that need to be processed. A greater gas charge (transaction fee) may be required to attract more miners to the blockchain. Transactions that include incredible gas prices will be completed in less time, while those with lower gas prices will take more time to finish.
● Lack of Liquidity
Liquidity is defined as the capacity of a financial asset to be converted into another financial asset or fiat money. You will have an easier time trading an asset with a high degree of liquidity, which will assist in keeping its price stable. It might be challenging to trade one cryptocurrency for another in the DeFi ecosystem since many projects involved lack liquidity. This may result in a rise in the cost of petrol. According to traditional finance, DeFi is only worth $54.05 billion when measured in terms of market capitalization.
● Difficult to Use
If you are unfamiliar with bitcoin, using a defi product may be difficult. To successfully use the DeFi platform, you may need to seek the advice of a native crypto user. Customers may have a tough time making the transition to DeFi as a direct result of the negative experiences they have had.
Future of DeFi
In 2021, the cost of transactions using DeFi will be lower, take less time, and be more secure as more blockchains, such as Polygon, Avalanche, and Binance Smart Chain, acquire significance. I believe the future holds much promise for DeFi since it has gained widespread popularity over the last several years. A significant amount of recent progress has been made on the scalability and security of DeFi.
