DeFi, also known in full as Decentralized Finance, is a complete ecosystem of financial applications built on other blockchain networks. Decentralized Finance also represents a movement focused on creating transparent financial services, open-source and permissionless - meaning international financial products and services are accessible to everyboody and operating without a central authority.
In essence, decentralized finance applications allow users to exercise full control and ownership of their assets as well as the interaction within the financial sytstem using a peer to peer model.
The distinguishing element between DeFi and cryptocurrencies is the former fully focuses on decentralization while using lucrative incentive structures as an approach to encourage investors to take part in the movement. More so, DeFi has grown through crowd-funding startup models called ICOs (initial coin offering) and has been able to attract funding into projects quickly.
DeFi projects are software protocols running on top of a blockchain network such as Ethereum or Cosmos. These projects leverage the underlying protocol technology as well as new improvements to automate financial services.
DeFi projects earn this term because they are supposed to be fully non-custodial and decentralized. Non-custodial means the system doesn't manage or are control the user's crypto assets. DeFi projects allow you to be in full control of your cryptocurrency, you do not deposit your asset with a central authority.
On the other hand, decentralization in DeFi projects means owners of the project devolve or cede all their power of executing transactions to using smart contracts.
Defi projects are solving unique problems within the financial services industry.
DeFi projects focused on lending and borrowing allow users to lend and take out a loan by using software and bypassing the need to engage a trusted third party. Instead of using paper contracts, they leverage on the use of code to automate processes such as calculating interest rates and maintenance margins necessary in lending. For instance, a user wishing to lend part of their cryptocurrencies will send their desired amount to lend in form of tokens and or coins to an address controlled by the protocol. In return, they earn interest depending on the amount lent.
On the other hand, borrowers place the desired cryptocurrency by the borrower in the form of a cryptocurrency and will only borrow a percentage of the posted value. Examples of leading borrowing and lending DeFi projects include Compound, Aave, and yEarn.
Also known as DEXs, these are exchanges allowing users to exchange their cryptocurrency assets without the use of a mediator in the form of a centralized exchange. Decentralized exchanges operate as a true peer to peer exchange. They are increasingly becoming popular because users can instantly convert their cryptocurrencies, have quick access to trading pairs, high security and privacy of funds. The main examples of DEXs include Uniswap, Kyber Network, and 0x.
Derivatives are markets where buyers and sellers interact by exchanging a contract of an underlying asset based on the future value of that asset. Examples of these underlying assets can be cryptocurrencies, stocks, bonds, or an outcome of a future event. Examples of these DeFi projects include Synthetix, Augur, and Gnosis.
Individuals interested in trying out or diversifying their portfolio using DeFi projects need to follow the following steps:
Acquire an Ethereum wallet and using your browser connects it to the identified DeFi protocol.
Buy the appropriate coin or token for the particular DeFi protocol desired. For example, most of DeFi projects are live on the Ethereum protocol; hence one should buy ETH or any ERC20 token. If using Bitcoin, you should convert it to Wrapped Bitcoin wBTC which is an ETH version of Bitcoin.
You are not set to take part in the DeFi revolution by participating in the various use cases as discussed above. However, it is important to conduct their research as this is a high-risk high return space in the crypto industry. Besides, scammers and vulnerability to errors are quite rife in this domain.
Decentralized Finance is bent on revolutionizing traditional finance.
No intermediaries or arbitrators- DeFi projects use code that specifies the resolution of every possible future dispute. More so, users have control over their funds.Eliminates single point of failure- DeFi projects are built on top of blockchain networks, hence data secured by this technology and decentralized using thousands of nodes. Consequently, making it difficult to orchestrate shutdown or censorship of these new financial services.Secure and less complex- DeFi applications are built-in advance making the process of deployment easy and secure.Global access- DeFi applications are open ecosystems making it possible for anyone around the world to access financial services and products.
Overall, the cryptocurrency industry is ever evolving, as apparent with the introduction of DeFi projects. This innovation will no doubt unsettle present workings of traditional finance. However, users and enthusiasts should be cautious when making investments into some of these projects as some are prone to schemes and scams.
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