In the blockchain world, DeFi has become a hot issue. In contrast to the decentralized money achieved via Bitcoin, DeFi seeks to decentralize the conventional financial system in general. The initiative’s fundamental goal is to make conventional financial services available to everyone by creating a permissionless financial service ecosystem built on blockchain technology.
What is DeFi?
Decentralized finance, often known as DeFi, is a technology that allows financial products to be made accessible on a public decentralized blockchain network. As a result, instead of passing via intermediaries like banks or brokerages, they are available to everybody. Unlike a bank or brokerage account, DeFi does not need a government-issued ID, Social Security number, or proof of residence.
For more information on Defi, its source, and its advantages, read our blog on what is Defi?
What keeps a DeFi ecosystem together?
There are two major components: a circular economy and blockchain technology:
1) A circular economy
The mutual drive of value is the first piece of glue that holds DeFi together. In other words, if money continues to circulate, the economy continues to function, just like any other.
New value enters the system in two ways:
- Deposits – People deposit money into the system to earn income from it being put to work in the DeFinancial system, in the same way that people earn interest in bank savings accounts by putting their money to work in the old financial system.
- Useful blockchain applications – Data markets, games, accounting software, distributed computing services, and many more applications are part of the DeFi ecosystem and may charge fees for their services.
In this approach, the DeFi ecosystem’s never-ending desire to capture value ensures that everyone’s incentives align to building and supporting the most truly valuable dApps.
2) The blockchain
DApps are built on blockchain technology which explains why they perform so dependably and integrate so well. This implies they are completely transparent, that anybody can examine their code to know precisely how they function, and that they are guaranteed to obey their code.
Consequently, dApps may instantaneously trust each other and begin conducting business together without the need for attorneys, contracts, and other formalities.
This is made feasible by underlying blockchain technologies that allow dApps and enable them to connect. Finally, the DeFi ecosystem is only as safe as the blockchain architecture that underpins it.
The Ethereum blockchain, which serves a broad variety of DeFi dApps, is now the most popular blockchain fabric.
Why is there so much craze about DeFi?
First, regulators have been slow to catch up, allowing DeFi to thrive in the void. For example, in conventional unsecured lending, lenders and borrowers must know each other’s identities, and the lender must evaluate the borrower’s capacity to repay the amount. There are no such criteria in DeFi. Instead, everything revolves around mutual trust and the preservation of privacy.
Regulators must strike a fine balance between inhibiting innovation and failing to safeguard society from hazards such as people placing their money in an unregulated sector or banks and other financial institutions possibly losing their ability to profit as intermediaries.
Another factor for the DeFi boom is the involvement of mainstream players. Many traditional banking institutions are starting to adopt DeFi and are looking for ways to join. For example, as part of the Interbank Information Network, 75 of the world’s largest banks are testing blockchain technology to speed up payments, led by JP Morgan, ANZ, and the Royal Bank of Canada.
Major asset management firms are also beginning to take DeFi seriously.
The third impact is that of COVID-19. The epidemic has pushed down global interest rates even more. Some countries, such as the eurozone, are currently in negative territory, and others, such as the United States and the United Kingdom, may follow.
In this environment, DeFi can provide far greater returns to investors than traditional financial institutions.
One last major reason for the increase in individuals investing in DeFi tokens is to prevent missing out on their spectacular development. Many tokens are worth nothing or almost nothing in practical terms, resulting in excessive excitement.
But, whether we like it or not, we are on our way to a new financial system that is more liberal and decentralized than the one we have now. The essential challenge is how to effectively direct its growth via checks and balances that minimize dangers while spreading potential advantages as far as possible. That will be the problem in the next few years.
3 Easy Steps to Get Started Investing in DeFi
Here’s how to get started with one of the most prevalent DeFi applications: lending and borrowing assets.
Create a Crypto Wallet
The first step is to choose a cryptocurrency wallet.
Your wallet will be where you save, transmit, and receive DeFi coins. Wallets exist in various forms, and some are also linked to exchanges where you may buy DeFi coins.
Get your DeFi coins
Following that, you must invest in the coins compatible with the DeFi protocol in which you want to participate.
Most protocols are currently built on Ethereum. Thus you’ll most likely be acquiring Ether coins or ERC-20 tokens.
Take Part in Your Favorite Protocol
Lending and borrowing are essential components of DeFi, just as they are in our old financial system. However, one of the advantages of DeFi is that it allows users to borrow and lend assets without losing custody of their currencies.
DeFi and Ethereum
Ethereum is the ideal basis for DeFi for many reasons:
No one owns Ethereum or the smart contracts that run on it, allowing everyone to utilize DeFi. This also implies that no one may impose new regulations on you.
Behind the scenes, all DeFi gadgets communicate in the same language: Ethereum. As a result, several of the items function in tandem. You may lend tokens on one platform and trade the interest-bearing token in another market on a completely separate application. This is similar to being able to cash in your reward points at your bank.
Tokens and cryptocurrencies are built into Ethereum, a shared ledger – keeping track of transactions and ownership is something Ethereum does well.
Ethereum provides total financial independence — most goods will never take custody of your assets, allowing you to maintain complete control.
The overall purpose of cryptocurrencies is to improve on the mechanisms we have in place to build a more efficient, scalable, and accessible world of money. Decentralized finance extends that accessibility by fostering a more open monetary environment.