What is DeFi? Decentralized finance, or DeFi for short, is a growing sector of the cryptocurrency industry. It refers to blockchain technology to create decentralized financial products and services. Experts in Cryptocurrency know that they are not controlled by any central authority and can be accessed by anyone. This beginner’s guide will explain what DeFi is and how it works. We will also discuss some of the most popular DeFi projects and platforms.
What Exactly Is Decentralized Finance?
Decentralized finance—often called “DeFi”—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain. From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments.
By deploying immutable smart contracts on Ethereum, DeFi developers can launch autonomous platforms and products that run exactly as programmed and are available to anyone with an Internet connection. The breakthrough of DeFi is that crypto-assets can now be used in ways not possible with fiat or “real world” assets.
Put, DeFi is programmable money. And through composability —the ability of protocols to work together—the possibilities are virtually endless. The rise of DeFi protocols has given birth to an emerging ecosystem of integrated applications and products known as the available finance stack.
From Maker and Compound to Synthetix and Balancer, the stack comprises various protocols that enable lending, borrowing, staking, trading, and much more. Collectively, these protocols offer a comprehensive suite of financial services that rivals traditional centralized counterparts like banks, brokerages, and exchanges.
The defining characteristic of DeFi is that it’s permissionless—anyone with an Internet connection can access these protocols and products. Crypto wallets like MetaMask, Gnosis Safe, and Argent help users interact with decentralized applications (dApps) built on Ethereum. These user-friendly interfaces make it easy to get started with DeFi without knowing how to code.
What Are the Benefits of Decentralized Finance?
The breakthrough of DeFi is that crypto-assets can now be used in ways not possible with fiat or “real world” assets. By deploying immutable smart contracts on Ethereum, DeFi developers can launch autonomous platforms and products that run exactly as programmed and are available to anyone with an Internet connection.
This paradigm shift has many benefits.
DeFi is censorship-resistant
Because DeFi protocols are built on the Ethereum blockchain, they are immutable and cannot be censored or shut down by any central authority. This makes them ideal for users in countries with oppressive regimes or financial systems.
DeFi is available to everyone
Another benefit of DeFi is that it’s available to anyone with an Internet connection. There are no KYC or AML requirements, and users do not have to go through a centralized institution like a bank to access these services.
DeFi is borderless
DeFi protocols are also borderless, meaning anyone can use them. This makes them ideal for users in countries with unstable economies or financial systems.
DeFi is transparent
All transactions on DeFi platforms are recorded on the Ethereum blockchain, which is public and transparent. This transparency helps to create trustless relationships between users and platform providers.
What Are the Risks of Decentralized Finance?
While DeFi offers several benefits, there are also some risks to consider before getting started.
The most significant risk is that of smart contract vulnerabilities. Because DeFi protocols are built on smart contracts, they are subject to the same vulnerabilities. In 2016, exposure to the DAO smart contract led to the loss of $50 million worth of ETH. While this was an isolated incident, it highlights caution when using DeFi protocols.
Another risk is platform risk. Because DeFi platforms are still relatively new and unproven, they may be less stable and more prone to hacks than traditional financial institutions. This was exemplified by the 2018 Parity Wallet hack, which resulted in losing $30 million worth of ETH.
Finally, there is the risk of liquidity. Because DeFi protocols are still in their early stages of development, they may not have the same level of liquidity as traditional financial markets. This can lead to price volatility and make it difficult to exit a position.
How to Get Started with Decentralized Finance?
If you’re interested in getting started with DeFi, there are a few things you need to know. First, you’ll need to set up a cryptocurrency wallet that supports Ethereum. We recommend MetaMask, Gnosis Safe, or Argent.
Once you have a wallet set up, you’ll be able to access decentralized applications (dApps) built on Ethereum. These dApps are where you’ll be able to interact with DeFi protocols and products.
One of the most popular apps in the DeFi space is MakerDAO, a platform for creating and managing decentralized collateralized debt positions (CDPs). You’ll first need to deposit some ETH into a CDP to get started. Once your ETH is locked up in a CDP, you’ll be able to create Dai, a stablecoin pegged to the US dollar.
Conclusion
DeFi is a new and exciting area of the cryptocurrency space that offers many benefits over traditional financial institutions. While some risks are to consider, we believe the potential rewards outweigh the risks. If you’re interested in getting started with DeFi, we recommend setting up a cryptocurrency wallet and exploring some of the popular dApps in the space.
