If you have been reading up on cryptocurrencies, you would surely come across the term DeFi by now. It is short for Decentralized Finance which is used mostly in cryptocurrency applications.
Background of DeFi
DeFi is used vastly where its idea stemmed from the blockchain. This umbrella term has since disrupted most of the financial intermediaries across the world. Blockchain is the platform that drives the digital currency where several parties store and manage the ledger containing transaction histories. This means that the blockchain is not controlled by any centralized entity like how conventional financial institutions function. With that as the underlying model, DeFi is able to expand its power and capabilities to more than just value transfer or transactions.
What differences are there?
With digital assets, you use a different platform as compared to the conventional kind because there is no need for middlemen anymore. If you make a payment using your Visa credit card, the financial institution will exist between you and the firm. The financial institution will be responsible in deciding if your payment is successful through the management of a private ledger it controls. Digital assets function in a totally opposite way.
But this is not only limited to buying items or products. With the ability to provide decentralized management and a public ledger, more applications can now be possible. This includes providing loans or insurance, derivatives, crowdfunding and even education. With DeFi, the middlemen are cut off.
Smart Contracts the core in DeFi
DeFi applications are built on top of the second-largest cryptocurrency platform in the world, the Ethereum. What makes this crucial is that Ethereum is supposedly easier to use especially when needed to build applications that are decentralized. Such is the case with smart contracts, a common term used in Ethereum platforms. Smart contracts allow automatic execution of transactions by the meeting of certain conditions which also has better flexibility as well. Solidarity is the language used mainly to design smart contracts and rules can be implemented very easily.
This means you can adopt a rule that a certain amount can be transferred if the FBM KLCI reached 1,500 points and it will then be implemented automatically. With Ethereum 2.0, DeFi is set to become more popular since smart contracts operate at its nucleus. Among the popular applications of DeFi are:
- DEXs – Short for decentralized exchanges, these are typically platforms that allow you to exchange digital currencies for other (fiat) currencies. Unlike DAX (Digital Asset Exchanges), you are connected directly to other users without going through a broker.
- Prediction markets – Used mostly in DeFi, these are markets that traders put their money on predicting the outcome of events. Basically, these are like betting platforms without the need of middlemen.
- Stablecoins – These are cryptos that are directly tied to an external asset and usually a fiat currency like the US Dollar. The idea is to ensure the price is stable.
- Lending platforms – Traders use this to manage the lending and borrowing instead of middlemen like banks.
Some of the things you need to know about DeFi are:
- Money Lego and Composability – Refers to the ability to create new apps since DeFi apps are open source. Meanwhile, Money Lego is a way to look at compossibility where you can create worlds and structures through the blocks.
- Yield farming – Usually played by the experienced traders, they scan different DeFi tokens looking for good returns.
- Liquidity mining – One of the most popular yield farming around where the DeFi app will give you free tokens in trying to get you to get to their platform
So, what is the verdict?
There has been an ever-expanding market in Ethereum DeFi projects. Users have been profiting a lot using the likes of landing apps. Those who are willing to take higher risks can try yield farming but it is still a very risky venture. There are a lot of projects out there. DeFi is definitely moving in the right direction with some calling it the future of finance. New users must evaluate all projects before putting their money there. In whatever case, smart contracts is the way to go and DeFi is in the middle of it all. So, be cautious, do your homework and invest wisely.