What is DeFi (Decentralized Finance)?

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What exactly is DeFi and why is it such a hot topic?

Decentralized finance, or DeFi for short, uses public blockchains such as Ethereum, Avalanche, Cosmos, and other smart contract blockchains to create traditional financial instruments without reliance on intermediaries like banks or governments. The emergence of DeFi has captured the attention of crypto entrepreneurs looking to build new financial solutions that are more transparent and accessible than centralized financial systems, driven by rapid technological development and adoption. In this blog post, we will explore the concept of DeFi in more detail. We will discuss why it has become one of the most talked about topics in the crypto world.

Potential DeFi Use Cases

DeFi has marked staggering growth in the crypto industry in 2020, where there was already over $11 billion locked in Ethereum DeFi platforms and more than 100,000 crypto-users as of October 2020. Before interacting with any DeFi platform, know these prominent DeFi use cases allow you to par with DeFi’s dynamic changes.

Open Lending Platforms

Open lending platforms usually have decentralized applications (DApps), making them preferable to crypto people. This platform provides digital asset lending or borrowing services to and from other crypto-users with added interest.

Borrowers should typically deposit collateral worth more than the amount loaned and must sustain their collateral for more than the specific value threshold, protecting the borrower. If the borrower fails to comply and the loan-to-value (LTV) ratio falls below the level, the collateral becomes a reimbursement for the lender.

Stablecoins

When somebody wants to maintain liquidity while evading volatility, Stablecoins is the typical choice. With its utmost stability, lenders, borrowers, traders, and liquidity providers get hooked on this DeFi method. This digital asset pegged a specific value to a different asset to reduce volatility while keeping the price stable. Some examples are:

  • The US dollar (USD) or Euro (EUR)
  • Gold
  • A variety of assets (Facebook’s Libra Stablecoin)

Decentralized Exchanges

DeFi also lacks centralized authority, similar to automatic market makers (AMMs) like Curve. Decentralized exchanges, or DEXs, trading platforms use basic mathematics in setting the price in the liquidity pool’s token. A DEX can also use the ask/bid system set by its order prices.

Meanwhile, some DeFi marketplaces with a DEX-like system (i.e., OpenSea) allow users to utilize a smart-contract-based escrow system to deal with digital goods but in a dubious manner.

Decentralized Insurance

DeFi platforms now provide similar functionality with insurance policies, where the user has enough insurance coverage during an unforeseen accident. Decentralized insurance can be a way to protect yourself from potential destructing events like failure of smart-contact, hack, and market crashes.

However, decentralized insurance investors share the same risks in return for their insurance premiums. Meanwhile, these platforms have accessible payout methods built under smart contracts visible to the public to avoid any unclear fine print.

Staking

Due to its simplicity, this DeFi use case is typically the first-way digital asset holders gain decentralized finance exposures. The staking method allows users to help each other join in the network governance of Proof-of-Stake (POS) blockchains using two methods:

  • Through the validator node’s digital asset delegations
  • Via a compatible wallet to store digital assets

The more the users help secure blockchains through asset staking, the more rewards they can earn, delivered automatically by the network.

Why Should I Care About DeFi?

DeFi methods and products are inherently transparent due to its platforms built using uncensorable networks and open-source software, making it accessible to anyone with an internet connection. 

DeFi has the power to connect various people worldwide, engaging in financial activities like borrowing, spending, betting, lending, and trading) without relying on any intermediaries. Although the DeFi concept is still premature, its convenient and sufficient processes introduced a new financial model that is:

  • Transparent
  • Uncensorable
  • Collateralized
  • Composable
  • Accessible
  • Inclusive
  • Permissionless

It is evident that today’s global financial system has flaws caused by excessive borrowing and opacity, so it must provide an alternative through decentralized finance.

Earning money with Yield Farming

Yield farming is also called liquidity mining. This DeFi use case is more recent, where users can lock digital assets in exchange for rewards and deliver them automatically through the smart contract. Most projects of yield farming require staking liquidity provider tokens, which are received once the user provides the liquidity. 

Yield farms typically have high rewards and risks, as any loophole in a smart contract can result in locked asset loss. Here are some things to note to earn money in yield farms, especially for beginners:

  • The liquidity pool is where liquidity providers deposit funds.
  • Funds are usually in Stablecoins linked to USD, like USDC, USDT, etc.
  • Earning another incentive for additional funds might be for accumulating non-open market or low-volume tokens through liquidity pool rewards.
  • The returns and the protocol rules depend on the amount invested in the platform.
  • Different reward tokens are attainable and available by reinvesting reward tokens into another liquidity pool, allowing yield farm entrepreneurs to create complex chains.

Investing through yield farming provides a lot of profit, especially if a user arrives early enough to adopt a new project. Generate token rewards by selling or reinvesting them to shoot up their value. 

Conclusion

The world of DeFi is continuously growing and innovating and becoming a more significant part of the crypto ecosystem. The use cases are very broad and can give a lot of benefits with high yields. It is very complex for new users in this space, though. Most DeFi platforms are experimental as well, which brings extra of losing your money. That could happen due to user mistakes, smart-contract exploits, or bad intentions by the often anonymous creators.

This article explains the concept of decentralized finance (DeFi) and its use cases, including open lending platforms, stablecoins, decentralized exchanges, decentralized insurance, and staking. It also highlights the benefits of DeFi, such as transparency, accessibility, and inclusivity, and discusses yield farming as a way to earn money in DeFi. However, it also emphasizes the risks involved, including smart contract exploits and user mistakes.

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