A Beginner’s Guide to DeFi – It’s Simple!
The future of finance is here
If you’ve been keeping up with the dynamic and fast-paced cryptocurrency world, then you might have heard of a movement known as decentralised finance (DeFi).
DeFi is a budding concept, a new yet strangely familiar idea that financial activities can be carried out without intermediaries.
More than just digital currencies that are independent of a central governance, DeFi utilises the transparent and accessible nature of blockchain technology to create an open and global financial system; an autonomous network free from middlemen like banks, lawyers, or brokerages.
To ‘get’ DeFi, it’s useful to have an understanding of the current financial infrastructure and its apparent flaws.
The finance that we’re familiar with is managed by central authorities. Fiat currencies (‘money’ that we use) are government-issued and financial institutions are bound by the laws and regulations of each country. Financial services are indirectly accessed via third parties like banks and exchanges, with consumers essentially allowing intermediaries to control their assets.
The problem with traditional finance is that it’s costly; the keyword being ‘intermediaries’. For example, banks (an intermediary) can only offer minimal interest rates on deposits, enabling them to profit when it’s lent to other consumers at a much higher interest rate.
Inequality is also a defining feature of traditional finance. Try taking a loan from a bank and you’ll be asked to fulfil income requirements and pass background checks. It’s 2021 and yet 1 in 3 people around the world are still unbanked, significantly reducing their chances of starting a business or purchasing a house.
Check out our beginner’s guide on blockchain and cryptocurrencies:
DeFi ‘defies’ conventional finance simply because it’s the antithesis of centralised financial institutions.
Instead of physical organisations, most DeFi platforms run on the Ethereum blockchain — a public network accessible by anyone with an internet connection. Smart contracts (automatic and self-executing digital contracts) eliminate the need for costly human intermediaries and ensure that the terms of the financial ‘contract’ are met.
This means that location, nationality, and social status are no longer pertinent. DeFi essentially democratises finance, making it more accessible and equitable. Everybody can now have full control of their assets and directly participate in peer-to-peer financial transactions without the dictation of middlemen.
This is also why DeFi is often described as ‘borderless’; financial activities can now be performed on the same network from anywhere across the globe. Quite literally the ‘internet for money’!
There are multiple DeFi applications including:
Lending protocols — Users lend their cryptocurrencies at a much higher interest rate (no more fees paid to an intermediary like a bank). Assets can also be borrowed against collateral.
Derivatives — Users can trade derivatives such as options and perpetual bonds with their value derived from an underlying asset like cryptocurrencies and/or real-world assets including stocks, indices, forex, and commodities. There is no need for a broker (an intermediary) because smart contracts automatically execute the settlement once the terms are met.
Decentralised Exchanges (DEX) — Unlike centralised cryptocurrency exchanges, DEXes do not manage users’ funds. Anyone with an Ethereum wallet can choose to provide liquidity (contribute funds in cryptocurrencies) and/or swap tokens.
Oracles — Think of DeFi Oracles as the bridge between real-world data and DeFi platforms. Centralised exchanges have access to crucial information like the price but smart contracts on DeFi platforms are merely digital contracts with no knowledge of that data. Oracles upload the required information to the blockchain where it’s then absorbed by the smart contract.
Insurance —Decentralised insurance platforms are not insurance companies. Decentralisation means that it’s run entirely by community members with claim decisions enforced by smart contracts. These platforms safeguard users against risks including smart contract hacks, wallet attacks, and volatility/flash market crashes.
Asset Management — Similar to traditional finance, asset management in DeFi is about managing cryptocurrency assets and effectively investing them for profit. Some of these platforms help users to maximise their profits by connecting them to lending and liquidity pools with the most yield (We’ll be covering yield farming in next week’s article).
It’s often said that blockchain and cryptocurrencies are like the early 1990s of the internet. While uncertainty, challenges, and criticisms are inevitable, we can only imagine DeFi’s disruptive potential, and how it might well be the new bedrock for global finance.
Keep Tokenizing! Look out for our more in-depth guide on DeFi next week!
Still confused about blockchain and cryptocurrencies? We get it! Check out our previous Tokenize Research articles:
Here at Tokenize, we strive to provide the best possible platform for cryptocurrency trading. More importantly, we believe in sharing our passion on all things blockchain, crypto, and DeFi.
