Cryptocurrency

What is DeFi and how does it work?

What is DeFi?

DeFi, also known as decentralized finance, is a system of payment that utilizes peer-to-peer payment methods through blockchain technology. DeFi eliminates the need for an intermediary required before transactions could be carried out successfully in the traditional method of finance. DeFi in such a way that financial activities could be carried out autonomously without the input of a third party, and it is able to achieve this using a smart contract.

How does DeFi work?

DeFi does not really change the services that financial institutions offer, rather it introduced a new method to the industry. This means that financial services such as payments, investments, insurance, and loans are still very much in place but in a much more efficient way with the use of blockchain technology. In other words, DeFi makes a new financial framework available for similar financial products and services.

Two major components must be available in any traditional financial system: an infrastructure on which the system will operate on and a currency it will work with. In the traditional system, banks and other financial institutions function as the infrastructure while fiat money such as the US dollar, pounds sterling, euros, etc., function as the currency. For decentralized finance to fully become operational, it must replace these two components.

Majority of decentralized finance is built on the Ethereum network, a blockchain platform that allows users to build decentralized apps (dApps). Although, other similar blockchain platforms are coming up such as Cardano, Binance, and Solana, Ethereum is still the most accepted among developers and its early adoption is an added advantage over other alternatives.

Through the use of dApps, interested parties could transact directly without any need for middlemen. Smart contract makes the elimination of middlemen possible because, with them, you can create a set of commands for how a financial service will work. Once the smart contract has been deployed on Ethereum, it can’t be altered by anyone.

What is a smart contract?

A smart contract is a computer program that acts as an automated agreement between two parties. It uses blockchain technology for processing which means it can function without external input and it can’t be modified the moment it is set up. The transaction is complete only when the set rules have been met.

Why is DeFi Important?

Fiat currency is stored via financial institutions and this means that there are many third parties involved in your finances. You need to go through the traditional banking system before you transact. This process is tied to a central control system which sometimes could be slow and expensive in a sense because of the transaction fees. Transacting through a centralized system also means that financial institutions will have access to all your transaction records.
This is why decentralized finance is important because you won’t need to worry about transaction speed or transaction fees, and all your transaction records are safe and secured

Benefits of DeFi

Decentralized finance uses the blockchain technology elements and as such shares the same benefits that come with using blockchain.

Permissionless

Decentralization is the main underlining structure of blockchain technology which helps in having to depend on corporations. DeFi uses the permissionless nature of blockchain to rule out the need to depend on any central control body before a transaction could be carried out and takes over responsibilities like data storage and server space.

With decentralized finance, anyone with internet access can access the decentralized service without restriction. This implies individuals need not depend on banks or any financial regulatory body before they can perform financial activities like trading, investing, and loans.
Since there won’t be any need for intermediaries, this takes away charges that users normally pay per transaction, although some crypto fees such as gas fees may still apply in some conditions.

Transparency

One of the many benefits that come with using a blockchain-aided system is transparency. All the transaction activities carried out on the blockchain network can be found on the distributed ledger and this is shared by everyone, and they can access the network’s data. Furthermore, information is only recorded only after it has been authenticated and verified using a blockchain technique called cryptography.
With transparency, people can easily identify possible scams because they can see all changes in transactions as they are time-stamped so it is easy to know who made a such change, the time, and the way the change was made.

Immutability

DeFi utilizes blockchain properties like cryptography and consensus algorithms like proof-of-work to ensure that its records are immutable. With the help of immutability, records are kept secured on the blockchain network such that manipulating them will be practically impossible. In addition, the adoption of smart contracts also further aids in protecting transactions against bad users and preventing fraudulent activities.

Save Applications

Decentralized finance offers saving applications that let users manage their assets effectively. The same way people earn interest is when they save money with traditional banks, with saving applications, then it is possible for people to start earning in form of crypto from the assets they locked in lending protocols. To better understand how this works, you need to know about yield farming.

Tokenization

Tokenization is one of the prominent discussions that emerge from the introduction of blockchain technology. Tokenization generally is the process of removing sensitive data like credit card data and replacing them with some string of characters called tokens while retaining all essential information about the data.

In blockchain, tokenization involves transforming tangible or non-physical assets into crypto tokens. Crypto tokens function as digital assets on the blockchain and it has other usages and features as well. Tokenization has started to gain recognition in come industries such as real estate, artwork, and equities. Some of the common tokens are utility tokens, transactional tokens, platform tokens, government tokens, and security tokens. For more on tokenization, check here.

How to invest in DeFi

A lot of DeFi projects have been launched into the crypto space, and it can be challenging to choose the one to invest in. As a general rule of thumb, DeFi projects that promise quick high token returns for doing absolutely nothing are most likely a pyramid scheme and it is advisable to stay away from such because they won’t be around for too long. It is highly recommended that you stick to DeFi projects with high liquidity and with a substantial amount of cryptocurrency staked on the platform.
Some DeFi investment strategies for you to consider are DeFi coins, staking, yield farming, and DeFi stocks.

DeFi is still at an early stage and a lot of investment opportunities are available for early action takers. If you are fascinated by these opportunities, and you want to know how to invest in decentralized finance, follow the steps given below:

  1. Get your crypto wallet

The first step of course will be to get your crypto wallet with which you will store your crypto. There are a lot of crypto wallets out there such as Binance, Coinbase, Metamask, etc.

  1. Purchase crypto coins

Before you can be able to participate in the DeFI protocol, you will add some cryptos to your wallet to lend your assets. Since most of the DeFi protocols are built on the Ethereum blockchain, it is, therefore, advisable that you get ether coins.

  1. Start transacting

Select from your wallet balance, the token you wish to deposit from with the amount. You will see the details of the proposed transaction on your screen and you can approve it once you are satisfied.

  1. Track your investment

If your transaction is successful, it means you now have a new token that represents your share of the pool and you can now begin to track your investment.

 

FAQ

What is a DeFi wallet?

DeFi Wallet allows you to save your crypto with DeFi wallet without relying on a third party. This is a secure way of saving your crypto assets as it gives you total control and you can always access it with your private keys.

What is a DeFi token?

DeFi tokens are tokens created in an open-source environment such as Ethereum blockchain and are issued as assets.

What is DeFi coin?

DeFi coin is a coin indigenous to a blockchain. For instance, we have Ether (ETH) as the indigenous coin for Ethereum blockchain, SOL as the indigenous coin for Solana Blockchain, ADA for Cardan blockchain, and BNB for Binance blockchain.

 

 

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