by Alan on 2021-02-14 filed under Crypto for Beginners
When you take to the web to research the correct type of cryptocurrency you want to invest in, you can often be swamped by a tide of information. In this overwhelming wave of information, we can often be faced with the term “DeFi.” This means Decentralized Finance, and in this article, we are going to cover what Decentralized Finance is, what you should look out for and how it works, a DeFi 101 for newbies if you will.
What is DeFi?
So, you may be asking, what is DeFi? Well, let us explore.
DeFi allows a group of users to hold a list of transactions and assets, sharing the data on a large scale via the blockchain. Resulting in giving freedom of information throughout the network, rather than a centralized system which often keeps the information purely internal.
Centralized systems often restrict the speed and efficiency of online transactions and connections between individuals and restrict the access with their customers or users have over their own finances. The DeFi way of working takes transferring assets and currency to a whole new level, making it easy to transfer far more complex assets with ease and whilst maintaining complete anonymity.
Digital based asset transaction blockchains simplify the ways in which we can transfer money, assets and other currency by essentially cutting out the middleman. When we say middleman, we are looking at you, PayPal. Customer to business and business to business transactions are normally completed through the use of a middleman entity. They process the transaction, sort the accounts and send the money on, for a fee of course. The beauty of DeFi is that it removes this requirement and allows peer-to-peer sharing without another entity profiting off the transaction.
The History of DeFi
This topic has been up for debate for a while now and some of the debaters would argue that decentralized finance started with the well-known Bitcoin. In 2009, however the real changes to the online financing sector swing around when Maker launched in 2017, revolutionizing the way users of the system could lend and loan money.
Maker is centred on the Ethereum platform. It allowed its users to issue a cryptocurrency that’s equivalent to the value of the U.S. dollar by using digital assets as a guarantee or collateral. It created a way for anyone to take out a loan without having to beg a middleman or go through a centralized marketplace.
Maker was essentially the first building block for a revolutionary open financial setup. Compound Finance is an open market for users to take out loans, and lenders to collect the interest rates. Uniswap, allows users to swap any tokens on the Ethereum platform, without restrictive permissions.
There is a mind-boggling amount of DeFi applications open to its users. These range from simple uses like enabling lending, borrowing and trading to very creative uses like lotteries.
Just to give you an idea, the asset value held within this system have now grown to over $3 billion in the last three years.
What are DeFi Platforms?
DeFi platforms are places in which users can go to seek out opportunities to engage in trading, betting and loaning, without those pesky middlemen getting in the way of their transactions. Below is a simple DeFi 101 to give you an idea of what is available.
The top three types of DeFi platforms are:
- Decentralized Marketplaces - Web based exchanges help users exchange currencies for other currencies without the use of middlemen charging fees. Decentralized marketplaces are a hot exchanges, which connect users directly so they can trade cryptocurrencies with one another without trusting someone else with their hard-earned finances.
- Lending platforms: These platforms do what they say on the tin. Allowing users to loan cryptocurrency from another, without the use of an intermediary.
- Prediction markets: Markets for betting on the outcome of future events such as elections. The goal of DeFi versions of prediction markets is to offer the ability to bet without the use of third parties and middlemen.
There are a number of other platforms and uses for DeFi, however, this list is a comprehensive overview of the main arenas in which people can play.
What are Lending Platforms?
Lending markets are most certainly a popular use of DeFi, it connects borrowers to those willing to loan a variety of cryptocurrencies. DeFi loaning is based on the collateral you put in place. This can range from a wide variety of assets which you must put up first in order for the loan to be accepted due to the anonymity of the system.
What are Prediction Markets?
Prediction markets allow their users to take an event and place bets on the outcome. This can be a sporting event, financial event or even the result of an election.
The idea is to make a profit in this game. With the use of prediction markets users of the system can often find themselves ahead of the curve, as opposed to others who use more centralized means of predicting outcomes.
Risks of Investing in DeFi
Although investment at an early stage could potentially lead to high earnings along the line, it is hard for people to distinguish between a good investment and a potential catastrophic loss.
One thing to consider before you buy is how volatile the market for DeFi currently is. The value fluctuates massively in a matter of hours. This causes investors to lose gargantuan chunks of capitol in the blink of an eye if they don’t research their investment thoroughly. Consider the amount of DeFi companies that took a monumental plummet in 2020, one example being YAM that lost $60 million in just over 30 minutes.
Bugs within the DeFi system are very common and although Smart contracts are powerful they can’t be altered or adapted should a bug be found within the system. This means that once the bug is in there, it’s there to stay. Of course, these aren’t reasons not to invest, just considerations to the wise, before they embark on the perilous journey of investing in DeFi.
DeFi has been in the public eye more and more in recent years, offering the growing community a wide variety of options in terms of financing for their endeavours. Whether it’s trading tokens, loaning out or taking on loan or even betting on the presidential election outcome, the use of DeFi applications is field of variety. The world of decentralized finance is most certainly looking interesting, and appears on the face of it, the future of financial investment, of course, only time will tell.
Disclosure: I/we have a long position in Ethereum, Maker, and Compound. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Big Time Crypto).
Additional disclosure: Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of cryptocurrency. Investors are advised to review all documents and press releases to see if the cryptocurrency fits their own investment qualifications.