Common questions asked about Decentralized Finance
Welcome to the latest issue of CapitalRollup Digest! Today’s digest is for July 20th and it should take you about 5:00 minutes. We’ll get right to it.
- What does the Market Look like today? (Top 5/10 popular Cryptocurrencies)
Common questions asked about Decentralized Finance
Decentralized finance has become popular thanks to the growing adoption of cryptocurrencies, however, for a lot of people, the concept of Decentralized Finance (DeFi) still feels vague and difficult to navigate.
Decentralized Finance is mostly described as financial activity that is done without any centralized authority like banks or government and one in which an individual controls and is responsible for all their financial activities.
In today’s newsletter, we’ll attempt to break down the concept of DeFi into simple structures that are easy to understand via some common questions people have asked about DeFi.
Ready to learn about DeFi? Let’s dive right in.
Question 1: What is Decentralized Finance?
Decentralized finance, or DeFi, refers to a new decentralized financial system that is built on public blockchains such as Bitcoin and Ethereum. The system removes the control, banks and institutions have over money, financial products, and financial services.
Decentralized finance eliminates intermediaries by allowing people, merchants, and businesses to conduct financial transactions through emerging technology.
In conclusion, the term DeFi may refer to a movement that aims to create an open-source, permissionless, and transparent financial service ecosystem.
Question 2: What makes DeFi from Centralized/Traditional Finance.
There are many things that make DeFi different from traditional financial activities and they include:
- Permissionless: With DeFi, anyone anywhere in the world can connect to the network and complete financial activities single-handedly without any need for central authorities or exchanges.
- Decentralized: With DeFi, nobody is in control. Since all activities exist and happen on the blockchain, records are kept simultaneously across a cluster of thousands of computers distributed around the network.
- Transparent: All transactions exist on the blockchain and can be verified by anybody at any time.
- Trustless: There is no central party required in a DeFi product.
- Censorship Resistant: Nobody has the control to alter and invalidate any financial activity that happens on-chain.
- Programmable: Developers can program applications into low-cost financial services. Assets that are handled on the product have all the native attributes of conventional tokens on a decentralized network.
Question 3: How Does DeFi Work?
Decentralized finance uses the blockchain technology that cryptocurrencies use. A blockchain is a distributed and secured database or ledger. Applications called dApps are used to handle transactions and run the blockchain.7
In the blockchain, transactions are recorded in blocks and then verified by other users. If these verifiers agree on a transaction, the block is closed and encrypted; another block is created that has information about the previous block within it.
Most of the existing and potential applications of decentralized finance involve creating and executing smart contracts. While a usual contract uses legal terminology to specify the terms of the relationship between the entities entering the contract, a smart contract uses computer code.
Question 4: What are the risks of DeFi?
While the idea of being in control of your finances sounds appealing and interesting, it is important to note that it comes with its own risks. Before you dive deep into the world of DeFi, here are a few risks you should know about:
1. Counterparty Risk: Since it’s not always possible to identify the person on the other end of a transaction, it can be easy to lose out during any transactions.
2. Token Risk: The assets you hold have different risk levels affected by their liquidity, trustworthiness, token smart contract security, and associated project and team.
3. Software Risk: Code vulnerabilities can undermine the security of smart contracts you’re invested in. Your wallet could also be compromised due to connecting to DeFi DApps and giving them certain permissions.
4. Scams: Similar to Central Finance, there are bad actors present in DeFi who are always on the lookout to scam users of their finances. These scams exist in the form of security breaches, fraudulent tokens, theft, and many others.
Question 5: What are some applications of DeFi?
Despite the young state of DeFi, there have been useful applications of decentralized Finance similar to traditional Finance.
Today, there are numerous DeFi lending platforms (or DeFi banks if you must), and decentralized exchanges that allow people to swap between and transfer tokens. We have also seen the rise of investments in the form of yield farming, decentralized insurance, and many more applications that exist and will exist.
In the future, there will be more applications for DeFi as more people become adoptors and the space grows to accommodate the different needs that may arise.
•Trivia 🤔
Is Web3 controlled by a central authority?
A. Yes
B. No
Find the answer in the next issue of CapitalRollup Digest. 😉
Crypto Word Of the Day!
💡 On-Chain
On-chain transactions are crypto transactions that occur on the Ethereum blockchain. These are subject to gas fees.
The term used in a sentence:
— Depending on the method used, off-chain transactions may eventually have to be recorded on-chain.
Community Update 📢
We organized a Twitter Space session with 3 industry leaders where we discussed “Share your Bear Market experience & CeDeFi implosions”, you can listen to it right here
•What We Are Reading Today 📰
What is DeFi? Crypto-based decentralized finance explained. Read more
Decentralized Finance (DeFi) Meaning. Read more
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