Decentralized Finance (DeFi) refers to all finance applications that run on decentralized, peer-to-peer networks rather than on centralized systems like those provided by banks and other financial institutions.
The emergence of DeFi over the past few years has brought about significant changes in how people conduct their financial transactions. In order to understand what DeFi means and why it’s important, you need to understand the current state of finance as well as its history over the last few decades. This article will provide an overview of both, so let’s dive in!
Introducing – What exactly is DeFi?
In recent years, two developments have made it possible to start building a decentralized system for financial applications. The first is an improved understanding of blockchain technology and cryptographic signatures; the second, is a growing interest in software-based systems for finance. From these two advancements, some interesting applications have been created: decentralized exchanges (DEXs), peer-to-peer lending platforms, and marketplaces with zero fees. But there’s still one question on everyone’s mind: what exactly are they? This post will take a look at DeFi—what it is, how it works, and its many potential benefits over traditional finance platforms.
Just as a quick refresher, here’s how decentralized exchanges work. The first step to making a trade on a DEX is to make sure that you have access to an internet connection. Next, make sure that you have an ERC20-compatible wallet installed. Then, visit one of your favourite DEXs—there are many options available—and create an account.
To start making trades, you’ll need to deposit funds. Depending on your DEX of choice, that could mean sending funds from your wallet to a smart contract address controlled by your chosen exchange or setting up an account with an integrated payment method like PayPal. Your next step will be choosing which token pair you’d like to trade. There are several different categories of pairs available at different exchanges, but they all operate roughly in the same way: there’s a base token and a quoted token which is used as collateral for trades. For example, if I wanted to purchase some Ethereum tokens (ETH) using my Litecoin (LTC) tokens as collateral, I would select ETH/LTC pair when making my trade.
The history of Decentralized Finance
Cryptocurrencies have been around for over 10 years now. It’s only recently that they’ve become accessible to non-technical users and became a household name. The term decentralized finance has been around for much longer, though, with P2P lending platforms like Lending Club being launched in 2006. More recently, DeFi tools have gained massive attention with tools like 0x relayers or MakerDAO or dYdX (all of which are covered in-depth below).
One reason for all of this attention on DeFi tools is that they offer users a way to have more control over their financial lives. Because these tools are connected to blockchains, they don’t need middlemen like banks or other traditional intermediaries (like centralized exchanges). This means users can avoid paying service fees and get their funds in a matter of minutes instead of days. It also means transactions are nearly instant and irreversible — that’s important for eliminating fraud risks involved with payment platforms. The same features make these platforms incredibly secure too, as there’s no single point of failure for attackers to target like there would be if one were using a standard banking platform.
And while they’re gaining a lot of attention, they’re not just good for users, either. DeFi tools have been designed with another key feature in mind: they allow developers to create decentralized financial products that don’t have any bank or middleman involvement. That means anyone can invest in them, whether through a traditional exchange or by directly buying tokens themselves. It also means it’s much easier to understand how these systems work because there are fewer moving parts and it doesn’t rely on anyone person — like a CEO — to be successful. Instead, it relies on network effects for its value to grow over time as more people get involved in using it.
Crypto Exchanges – A New Frontier
With centralized exchanges like Coinbase dominating trading, there’s a lot of demand for decentralized exchanges. A decentralized exchange gives users control over their funds rather than putting their trust in a third party—centralized exchanges, for example. Right now, centralized exchanges are all most people have access to; but that’s changing quickly. More projects are launching all the time, with Kyber Network leading the way. With options like these appearing regularly, there’s no telling how quickly deFi products will become ubiquitous. In fact, we might see DeFi overtake traditional finance within our lifetimes!
As with any new technology, there are challenges. The main issue with decentralized exchanges is that there’s currently no way to transfer funds on-chain. As a result, if users want to use them for trading, they’ll need another off-chain product such as OmiseGO’s PlasmaChain or Cosmos’ Tendermint in order to send funds back and forth. Some projects have already begun tackling these issues through—OmiseGO has announced that they plan to support cross-chain interoperability while EtherDelta recently completed their successful migration from Ethereum to Tron. The future of DeFi looks bright!
Other DeFi applications – A New Frontier: A number of other projects are going beyond just crypto exchanges too.
How Do I Invest in DeFi Without Getting Scammed?
Given how many scams there are out there in cryptocurrency, it’s understandable that a lot of people would be hesitant to invest their hard-earned money in something they barely understand. But DeFi can be quite lucrative (and profitable). Like any other type of investment, though, do your research. It’s up to you to decide if an opportunity is legit or not. Consider looking into online forums like Reddit where people who specialize in DeFi make posts about opportunities they’ve found. If a new project sounds too good to be true (or just interesting), that’s probably because it is.
If you don’t want to lose your money, you need to be smart about it. After all, just because something is an exciting new idea doesn’t mean that it’s going to turn a profit. To prevent being scammed, try to look at DeFi from an investment perspective rather than a gambling one. In other words, invest in stable coins or platforms that are already established instead of ICOs because their developers have done so much due diligence for you already (it can still be risky if those people misrepresent themselves). If there isn’t sufficient information on a project or you can’t find answers to your questions on forums like Reddit, consider giving it a pass.
Where To Go Next
Open finance platforms such as dYdX, Maker, Dharma and Compound are exciting because they allow users to become active participants in a decentralized global economy. While still in their infancy, there are already many examples of how decentralized finance will impact industries well beyond cryptocurrencies. If these projects can live up to their promises—and that’s a big if—you’ll be able to create your own financial portfolio with currencies from around the world. You’ll gain access to short-term loans backed by various digital assets (meaning they’re used as collateral), lending markets that include both cryptocurrency-backed loans with fixed interest rates and fiat-based loans with variable interest rates and more.
Cryptocurrencies have unlocked a global financial network, but it’s a network owned by middlemen. They decide who can access it and on what terms. They get to decide who gets loans based on their assessment of your creditworthiness, which is often biased against people in developing countries or with less-than-stellar credit scores (that’s about two billion adults worldwide). They decide how much interest you pay for loans or how much risk they want to take when investing in new projects.
If decentralized finance platforms succeed, all that could change. Instead of being forced to use high-interest services from banks—or even payday lenders—you’ll be able to borrow directly from people around the world.
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