Finance and Technology
Blockchain and Decentralized Finance
A Preface on Blockchain, Cryptocurrencies, DeFi, and DeFi Staking
With cryptocurrencies, blockchain, NFTs, and the whole crypto-space, in general, being the latest hype, one reckons it might be useful to learn what some of it means and how it works.
Generally saying the blockchain is the network on which you make transactions ie. where you send money, only instead of sending USD or any other Fiat currency, you’ll be sending cryptocurrency.
Before mentioning DeFi and DeFi staking, let’s cover some crypto first.
Simply said, it is a digital currency in which transactions are verified and maintained on a decentralized system.
To call something a cryptocurrency, there are some criteria it has to first fulfill.
What makes a currency a cryptocurrency
1. It’s a digital asset
2. Transactions are verified and maintained on a decentralized system
3. It must not rely on a centralized authority
4. Cryptography-secured transactions
5. It has a limited supply
The last one might not be universal to all, as there are currencies that do not have limited supply, but these are based on some more advanced terms.
Regarding limited supply itself — cryptocurrencies heavily rely on mathematics, by which limited supply was made possible. This practically renders it scarce as let’s say gold, unlike Fiat currencies.
Fiat currency is a currency that’s determined by an authority; or government, and isn’t backed or representative of another asset or financial instrument such as gold.
Both USD and EUR are Fiat currencies.
A system in which a record of transactions are decentralized, stored and maintained on a peer-to-peer network.
Blockchain is a network, and it’s made out of peers connected to each other, that manage all transactions.
One of the most important parts is that blockchain, the network and all of its peers, stores digital information, and transactions, distributes them, and allows no editing of that information.
That’s achieved by having all the peers track all the transactions.
If you, a single peer, would try to edit an old transaction (ie. Joe sent you $10, but you change that to $10.000), that edit would simply be denied by the network, because the network won’t trust your single-peer information.
This is why the decentralized networks are also called “trustless”, meaning there’s no single authority to be trusted, but the network as a whole.
DeFi, which is short for Decentralized Finance is just Finance but on the Blockchain. It is an instrument based on the distributed network and cryptocurrencies and, the most important part, it’s a technology that does not rely on centralized authorities or intermediaries.
With DeFi Finance, there’s no need for brokerages, exchanges, and banks.
If finance is the science behind managing money and funds, DeFi is the same
on the blockchain.
Decentralized Finance Staking
Decentralized Finance Staking, is the product of DeFi, altogether with cryptocurrencies and blockchain.
In the purest form, it is locking up an amount of money ie. crypto currency for a specified period of time. This is equivalent to locking your fiat currencies in your savings account in your bank.
The big difference is that individuals who keep their money in the bank, lose up on a lot of interests. Other options of traditional finance are High-Yield savings accounts, Money Market Funds, Bonds, etc. but traditional approaches depend a lot on a centralized authority.
With DeFi staking, by locking your crypto you become a validator in the network — or better said, you become part of the Proof-of-stake.
Many blockchains are based on Proof-of-stake, meaning in simple terms, all the transactions validates in the peer-to-peer network
How does this actually work
Proof-of-stake networks are too complex to be explained in a few paragraphs, but essentially it is staking your cryptocurrency in order to validate other transactions.
By staking your crypto, you will be generating a transaction which in turn will form a block with other transactions. Once a block of transactions is complete, it gets validated.
This is also the reason why you are getting more interest the larger amount you stake ie. the blocks are easier to complete.
With staking, individuals are helping validate the network and improving it in that way. Thus are getting rewarded with more cryptocurrency.
There’s nobody to hand that reward except the network itself, no centralized authority.
The mathematical algorithms that are the actual implementations of the blockchain dictate that.
Traditional interests you might get with locking and saving your money in the bank, are not remotely comparable to DeFi staking.
To simply illustrate the difference — imagine putting money in a centralized authority ie. the bank. You earn small interest, and the central authority makes much more with it, by just lending it to others. With DeFi staking, you are now in the role of that central authority, together with many other peers.
The goal of this story was to introduce the basics behind cryptocurrencies, blockchain, and decentralized finance, highlighting the benefits that individuals get.
Thanks for reading! 🎉