Decentralized Finance or DeFi is the economic paradigm shift enabled by decentralized technologies, specifically blockchain networks. From payment systems to automated loans, DeFi has emerged as one of the most active sectors in the blockchain space.
With DeFi, you can manage your own digital assets without relying on any financial institutions which can help you unlock potential revenue streams, but of course, it does come with its fair share of risks. DeFi is ever-evolving so by understanding the workings of decentralized finance you can adapt to these changes. Not to mention the information it provides you in order for you to have enough knowledge before interacting with any DeFi platform or protocol.
What is DeFi?
DeFi is still considered fairly new in the industry and it can be an exciting venture that offers many opportunities. This aims to elaborate on what is DeFi and how it works so it gives you the knowledge for you to work it to your advantage.
Decentralized Finance or DeFi, is a blanket term for tools and services used in the blockchain space. These blockchain-based tools and services aim to disrupt the traditional financial industry by mimicking banking, investing, and trading services. DeFi allows you to lend, loan, and exchange your digital assets with utmost security without having to involve third parties. With that being said, DeFi allows you to have full control over your assets independently.
DeFi differs from traditional finance which is built in a centralized setup. What this means is that everything is managed by a central governing body. It does have its cons such as having limited places to deposit your funds, making fund transfers longer and harder, excessive regulations, and so on.
The main focus of DeFi platforms such as Yield.App, Compound, and Aave are to minimize, if not eradicate all of these issues by helping you create a stable financial ecosystem. It gives you full control by proving an open-source, permissionless, and transparent system that is devoid of any central control. It’s also worth mentioning that DeFi lets you, the user, take control over your assets and interact with the system through decentralized apps or dApps.
Do take note that putting your assets into DeFi systems is not literally investing. Your participation in DeFi allows you to earn rewards for providing liquidity facilitating trade and enabling decentralized markets to function. There are different strategies to it which we will be talking about later, employing the best strategy can return a profit without it being exposed to price swings and market moods.
Usage of DeFi
As mentioned earlier, DeFi is not necessarily investment only. It’s so much more than just investments.
- Open Lending – One common use for DeFi is acting as a platform for open lending. It allows you to lend your assets to other users in order for you to earn interest or borrow someone else’s digital assets in which you’ll be the one paying the interest.
- Stablecoins – These are digital assets that have their value attached to another asset to minimize volatility making the price as stable as possible. Stablecoins are popular among lenders, borrowers, liquidity providers, and traders due to their stable nature.
- Decentralized Exchanges – DEXs are digital platforms that operate without a centralized authority that set the price of tokens in a liquidity pool with the help of automatic market makers or have a bidding system, where traders can set their own prices.
- Decentralized Insurance – This can be used to hedge against devastating events such as market crashes, hacking, contract failure, etc. It also allows a pool of investors to share risks among themselves in return for the insurance premium.
- Synthetic Asset Assurance – This one is a bit complex. It is essentially a process of creating a digital asset token that mimics the properties of something else. Similar to a stablecoin but it closely matches the value of an asset or currency that it’s pegged to. These synthetics can be bought, traded, and sold.
- Yield Farming – Also known as liquidity mining, this is a practice of locking up digital assets in return for rewards. Yield farms are considered a high risk/high reward since some locked assets can be lost if there’s a loophole in the farm smart contract.
- Staking – This is a simpler way for digital asset holders to gain exposure to DeFi. By either delegating digital assets to a validator node or holding it in a compatible wallet, the process will help you to participate in the network governance Proof-of-Stake blockchains.
Advantages and Disadvantages of DeFi
It is encouraged to explore DeFi to gain the right amount of knowledge on what is DeFi as a whole. Let’s look into the ups and downs of DeFi in order to make it easier to weigh the options before diving right in.
- Minimized Human Error – Many dApps like Yield.App have curated a list of well-tested audit strategies, which are assembled by experts in the industry. With that being said, it eradicates common risks due to human error thus minimizing risks and losses.
- Quick and Easy Access – Due to its decentralized nature, transactions are now easier and can literally be done with just one click. Anyone with access to the internet can use DeFi applications, may it be through mobile and desktop devices.
- Permissionless – In addition to ease of access, DeFi permissionless feature helps you with developing your own DeFi application for the world to use. Anyone can also participate in DeFi applications without having to worry about approvals.
- Transparency – DeFi provides its users with new levels of transparency. All transactions are publicly available meaning all activities on the blockchain are accessible by the public.
- Flexibility – Users are able to exercise more flexibility in their platforms. They give users the freedom to choose and build their own interfaces according to their own preferences.
- Responsibility – Giving users full control of their assets is somewhat of a risky idea. That is why understanding DeFi is key before diving right in because one wrong move can mean a huge loss for you.
- Risky – There are three common types of risks when it comes to DeFi and these include financial risk, procedural risk, and technical risk. Financial risks point out mostly to losing money and digital assets, procedural risks primarily focus on security risks associated with Defi, and lastly, the technical risks are pertaining to issues with protocols, hardware, and software for DeFi apps. So, research is really the key to minimize encountering these risks.
Whether you’re looking for insurance, exchanges, stalking solutions, etc., the DeFi platform has you covered. The pros of DeFi might outweigh the cons but please do bear in mind that DeFi is not without its fault. That is why the importance of research can’t be stressed enough so you can have a wonderful experience with DeFi platforms.