The Beginners Guide to Decentralised Finance or DeFi

The phrase “decentralised finance” (abbreviated as “DeFi”) refers to a broad range of financial applications in blockchain or cryptocurrencies that aim to undermine financial middlemen. DeFi is influenced by blockchain, the technology that underpins the virtual currency bitcoin. It enables many parties to each maintain a copy of a transaction history, preventing a single, centralised source from controlling it. This is significant because human gatekeepers and centralised systems may restrict the sophistication and speed of transactions while restricting the direct control that users have over their funds. DeFi stands out because it broadens the application of blockchain beyond straightforward asset transfers to more intricate financial use cases.

Because there are no middlemen involved in transactions with Bitcoin and similar digital-native assets, they differ from more established digital payment systems like those operated by Visa and PayPal. When you pay for coffee at a cafe with a credit card, a financial institution stands between you and the company, controlling the transaction, holding the power to halt or suspend it, and logging it in its own ledger. These institutions are no longer an issue with cryptocurrency. Big businesses regulate financial applications like loans and mortgages, insurance, crowdsourced fundraising, derivatives, betting, and more. Direct purchases aren’t the only kind of transactions that they monitor. One of the key benefits of decentralised finance is the elimination of intermediaries from any and all kinds of transactions. In fact, the concept of DeFi was frequently referred to as “open finance” prior to becoming widely known as decentralised finance.

Ethereum-based software

The majority of decentralised financial applications are constructed using Ethereum, the second-largest cryptocurrency platform in the world, which differs from the Bitcoin platform in that it makes it simpler to create decentralised applications that go beyond simple transactions. Even the architect of Ethereum, Vitalik Buterin, recognised these trickier financial use cases in the first Ethereum white paper from back in 2013. This is due to Ethereum’s smart contract platform’s greater flexibility, which allows transactions to be executed automatically when specific criteria are met. Solidity, an Ethereum programming language, was created expressly for developing and implementing such smart contracts.

For instance, let’s imagine a user requests that money be transferred to a friend on Tuesday, on the (for instance) condition that weather.com predicts a high of 90 degrees Fahrenheit. These regulations could be made a part of a smart contract easily. Numerous DeFi apps are running on Ethereum, a few of which are examined here, with smart contracts at their core. These applications may benefit from Ethereum 2.0, a network upgrade that may address scalability difficulties with Ethereum.

The most well-liked categories of DeFi software consist of:

• Decentralized exchanges (DEXs): These are online marketplaces that allow users to trade one currency for another, such as ether for DAI, or dollars in exchange for bitcoin. A popular form of exchange are DEXs, which link users up directly so they may trade cryptos with each other without having to entrust a middleman with their money.
• Stablecoins: These are a kind of cryptocurrency that ties its value to a non-cryptocurrency asset (such as the dollar or the euro) in order to control pricing.
• Lending portals: These are platforms that utilise smart contracts to replace middlemen like banks, that oversee and regulate lending.
• “Wrapped” Bitcoins (WBTC): These define a method of transferring bitcoins into the Ethereum network, in order to allow that it can be utilised immediately in the DeFi system of Ethereum. WBTCs enable consumers to receive interest on bitcoin loans made through the aforementioned decentralised lending networks.
• Prediction Markets: These are markets where bets are placed on the results of upcoming events, including elections. DeFi versions of these aim to provide the the same functionality as conventional markets, but without middlemen.

Besides these apps, many more DeFi ideas have also emerged around them:

• Yield farming: This is an option for experienced traders that are capable of taking risks. Users search through different DeFi tokens in search of chances to earn higher returns.
• Liquidity mining: This is a situation where DeFi applications offer consumers free tokens in exchange for using their platform. This is also the most popular type of yield farming to have emerged so far.
• Composability: Owing to their open-source nature, DeFi apps allow anybody to access the code that powers them. As a result, it can also be utilised to create brand-new apps.
• Money legos: DeFi apps are similar to Legos, the children’s toy blocks that can be joined together to make buildings, automobiles, and other objects, to simplify the concept of “composability” even further. DeFi apps can be put together in a similar way to “money legos” to create new financial products.

DeFi lending and borrowing

One well-liked method of decentralised finance that links buyers and sellers of cryptocurrencies is lending markets. Compound, a well-known platform, lets users take out loans in cryptocurrency or lend their own. Users that lend out their money can profit from interest. The interest rates are established by Compound using an algorithm, so if there is more demand for a cryptocurrency loan, it will also cause interest rates to go up, automatically. Lending in DeFi is collateral-based. Therefore, in order to obtain a loan, a borrower must provide collateral, frequently ether, the cryptocurrency that underpins Ethereum. Thus, unlike with typical, non-DeFi loans, customers are not needed to provide their identity or related credit score in order to apply for a loan.

Stablecoins

These are yet another variation of DeFi. Compared to conventional currency, cryptocurrencies frequently see larger price swings, which isn’t ideal for those would like to know the valuation that their money will have a week later, for instance. Stablecoins link cryptocurrencies to fiat currencies, such the dollar, in an effort to keep prices in check. Stablecoins attempt to create price “stability,” as the name suggests.

Stablecoins of note include:

• USD Coin (USDC)
• Binance USD (BUSD)
• Dai (DAI)
• Tether (USDT)

Prediction markets

These are one of the earliest DeFi apps still active on Ethereum, where users wager on the result of an event. The participants’ primary objective is to make money, yet sometimes prediction markets are more accurate than more traditional techniques like polls. Intrade and PredictIt are two centralised prediction markets with a solid track record in this area. Given that prediction markets are typically disapproved of by governments and frequently shut down when operated centrally, DeFi possesses the potential to increase interest in them.

More and more users all over the world are becoming acutely aware of the disruptive and equitable benefits that decentralised finance offers, in contrast to the inequity and bureaucratic regulations of conventional banking architecture. As such, in the years to come, DeFi could effectively one day replace legacy financial systems to usher in a more transparent and equitable tomorrow!

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