Decentralized Finance (DeFi): A Beginner's Investor's Guide

DeFi (or “decentralized finance”) is an umbrella term for financial services on public blockchains, primarily Ethereum.

With DeFi, you can do most of the things banks support - earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and more - but it's faster and doesn't require paperwork or a third party.

As with encryption in general, DeFi is global, peer-to-peer (meaning direct between two people, not routed through a central system), pseudonymous, and open to everyone.

What Is Decentralized Finance (DeFi)

DeFi is an acronym for (Decentralized Finance)which generally refers to digital assets, smart financial contracts, and decentralized protocols and applications (DApps) built on Ethereum.

In simpler terms, it is a financial software built on the blockchain that can be grouped together like Money Legos.

DeFi takes the basic premise of Bitcoin - digital money - and expands on it, creating a completely digital alternative to Wall Street, but without all the associated costs (office towers, trading floors, bankers' salaries).

This has the potential to create more open, free, and fair financial markets that anyone with an internet connection can access.

Here are some of the main advantages of DeFi for many investors are:

a)Eliminates the fees that banks and other financial companies charge for using their services.

b)You keep your money in a secure digital wallet instead of keeping it in the bank.

c)Anyone with an internet connection can use it without needing consent.

d)You can transfer money in seconds and minutes.

Some of the main disadvantages of DeFi for many investors are:

a)Decentralized finance, or DeFi, uses emerging technology to remove third parties in financial transactions.

b)DeFi components are hard currencies, software, and hardware that enable application development.

c)DeFi infrastructure and regulations are still under development and debate.

Decentralized Finance (DeFi) vs. Centralized Finance (CeFi)

In centralized finance, your money is held by banks and companies whose main goal is to make money.

The financial system is full of third parties that facilitate the movement of funds between parties, with each party charging a fee for using their services.

For example, let's say you bought an iPhone with your credit card. The fee goes from the merchant to the merchant's bank, which forwards the card details to the credit card network.

the network clears the fee and requests a payment from your bank. Your bank approves the fees and sends the approval to the network, through the merchant's bank, to the merchant.

Each entity in the chain receives payment for its services, generally because merchants must pay for your ability to use credit and debit cards.

All other financial transactions have high and expensive fees, loan applications can take days to be approved, and you may not even be able to use the services of the bank if you are traveling.

One of the main goals of DeFi is to reduce transaction times and increase access to financial services.

It ends decentralized finance on intermediaries by allowing individuals, merchants, and companies to conduct financial transactions through emerging technology. 

This is achieved through peer-to-peer financial networks that use security and communication protocols, and software and hardware development.

From anywhere you have an Internet connection, you can lend, trade, and borrow using software that records and verifies financial actions in distributed financial databases.

It can access a database distributed across different sites, it collects and aggregates data from all users and uses a consensus mechanism to verify it.

Decentralized finance uses this technology to eliminate centralized financing models by enabling anyone to use financial services anywhere, regardless of who they are or where they are.

DeFi applications allow users and investors to have more control over their funds through personal wallets and trading services that cater to individuals.

VERY IMPORTANT: While conducting a transaction away from third parties, decentralized finance does not provide anonymity.

Your transactions may not bear your name, but they can be tracked by entities that have access.

These entities may be governments, law enforcement, or other entities that exist to protect the financial interests of individuals.

How can you do with DeFi

DeFi is increasingly being used in both simple and complex financial transactions.

It is powered by decentralized applications known as 'dapps' or other software known as 'protocols'. Dapps and protocols process transactions in the two most popular cryptocurrencies, Bitcoin (BTC) and Ethereum (ETH).

While Bitcoin is the most popular cryptocurrency, Ethereum is more amenable to consolidation with a wider range of uses, so Ethereum-based code is used in much of the dapp and protocol scene.

Traditional Financial Transactions: DeFi is already used for payments, securities trading, and insurance, as well as lending and borrowing.

Decentralized Exchanges (DEXs): Most cryptocurrency investors currently use centralized exchanges such as Carret. DEXs allow users to control their money while facilitating peer-to-peer financial transactions.

E-wallets: DeFi developers are working on digital wallets that can operate independently of the largest cryptocurrency exchanges and provide investors with access to everything from cryptocurrencies to blockchain-based games.

Yield Harvesting: DeFi, dubbed the “rocket fuel” of cryptocurrency, allows speculative investors to lend cryptocurrency and can reap huge rewards when the proprietary coins paid out by DeFi borrowing platforms increase quickly to approve the loan.

Non-fungible tokens (NFTs): NFTs create digital assets from assets that are not normally tradable, such as videos of slam dunks or first tweets on Twitter. NFTs commodify what was previously immutable.

What are DeFi financial products

Peer-to-peer (P2P) financial transactions are one of the fundamental buildings behind DeFi. A P2P DeFi transaction is where two parties agree to exchange cryptocurrency for goods or services without the involvement of a third party.

To fully understand this, consider how to get a loan in central finance. You need to go to your bank or another lender and apply for one. If you are approved, you will pay the interest and service fee for the privilege of using this lender's services.

In DeFi, you will use a decentralized finance application (dApp) to enter your loan needs, and the algorithm will match you with peers that meet your needs. You will then need to agree to one of the lender's terms and receive your loan.

The transaction is recorded in the blockchain, you receive your loan after the compliance mechanism verifies it. After that, the lender can start collecting payments from you at agreed intervals. 

When you make a payment via your dApp, it follows the same process in the blockchain, and then the funds are transferred to the lender.

What is the future of investing in DeFi

Decentralized finance is still in the early stages of its development. For starters, it is unregulated, which means the ecosystem is still riddled with infrastructure incidents, hacking, and scams.

Existing laws have been formulated based on the idea of separate financial jurisdictions, each with its own set of laws and rules. DeFi's ability to transact without borders presents fundamental questions for this type of regulation.

For example, who is responsible for investigating a financial crime that occurs across borders, protocols, and DeFi applications? Who will enforce the regulations, and how will they enforce them?

We have to bear in mind the open and distributed nature of the decentralized financial system that leads to the problems of current financial regulation.

Other concerns are system stability, power requirements, carbon footprint, system upgrades, system maintenance, and hardware failures.

Many questions and progress must be answered before DeFi can be safe to use. Financial institutions will not give up one of their primary means of making money.

If DeFi is successful, banks and companies are more likely to find ways to get into the system, if not to control how you access your money, then at least make money from the system.

DeFi is designed to use cryptocurrency for transactions. The technology is still in development, so it is difficult to say exactly how, if any, current cryptocurrencies will be implemented.

Much of the concept revolves around a stablecoin, which is a cryptocurrency that is backed by an entity or tied to a fiat currency such as the dollar.

Disclaimer: The opinions and opinions expressed by the author should not be considered financial advice. We do not advise on financial products.