Understanding DeFi for Beginners

The decentralized finance (DeFi) space has been a trailblazer in the crypto industry for months now. Providing significant gains to investors and allowing many to profit has become a flag bearer on several fronts.

Understanding DeFi for Beginners

For many looking to get into the space, it is worth understanding what DeFi is and how it operates. So, let's take a look into DeFi and its meaning.

What is DeFi?

DeFi is an umbrella term used to mean several financial applications based on blockchain technology and cryptocurrencies. DeFi primarily draws inspiration for operation from the blockchain, allowing several parties to enter into a transaction without relying on intermediaries or middlemen. As enthusiasts know, the blockchain doesn't depend on control from a single or central source. This way, no party can restrict access or act as a gatekeeper to resources.

With DeFi, blockchain gets to meet traditional financial applications. You can enter into transactions with other parties and confirm transactions in little to no time while also enjoying optimal liquidity and other services, just like you're running on a traditional financial system.

If there's one thing crypto fans understand about digital assets, it's that they operate without permission or borders. As opposed to services like PayPal and Square, you can use Bitcoin to send money to anyone at any time. There are no middlemen, and you don't need to pay any intermediaries to process your transactions. However, with DeFi, you can do much more than just send money or pay for a product. You can give loans, contribute liquidity to cash pools, and even earn interest.

Some of the top DeFi applications available include:

  • Bet on future events and outcomes, thanks to platforms like Augur.
  • Build derivatives on real-world assets and exchange them using platforms like Synthetix.
  • Buy stablecoins - essentially, cryptocurrencies whose values are pegged to those of traditional fiat currencies.
  • Lending and borrowing cryptocurrencies, thanks to platforms like Aave and Compound. that allow you to earn interest on loans.
  • Participate in a no-lose lottery using PoolTogether. With the platform, a lucky participant gets all the interest, and others get their money back.

The Issues With Traditional Finance

Traditional finance will most likely always be part of how we live our lives. There's little that we can do to really change that. However, as we all know, there's a lot that's wrong with traditional finance.

Speed, Safety, and Costs

Let's start with the obvious ones. Traditional finance can be incredibly slow and costly. Sending money to a friend of yours outside the country will take days at least, and you will end up having to pay a significant percentage of the total sum to the payment processor or bank.

There is also the fact that traditional finance is susceptible to data breaches and hacks. Time and again, we've heard and seen instances where traditional finance systems get hacked and suffer security issues. DeFi doesn't necessarily end all of this, but it brings a paradigm shift and forces everyone to operate differently.

If you have all your money in the bank, several things could happen to it. The bank can increase service fees, or they could make bad investments with your money. The bank could also fold up or get robbed. In any of these scenarios, your money is gone.

With DeFi, you have access to a system that is relatively clear of these problems. Since services are free to use and decentralized, you enjoy quick and cheap transactions. You also enjoy optimal security, although there is no guarantee that security breaches can't happen. Essentially, the only fees you will have to pay are gas fees - costs for transactions that you spend on blockchains to get your transactions recorded and processed.

Financial Inclusion

Then, there is the problem of traditional finance being non-inclusive. Reports suggest that up to 25 percent of households in the United States are either unbanked or underbanked. When expanded, 31 percent of adults worldwide are reportedly unbanked.

Traditional finance is restrictive, and many people across the world remain unbanked. Some don't meet the criteria to open bank accounts, while others have one thing or the other that restricts them from accessing banking services.

Like cryptocurrencies, DeFi doesn't discriminate. Anyone with access to internet capabilities can open and operate an account and enjoy access to cheap, easy, and secure financial services.

Why the DeFi Craze?

DeFi has been able to rise significantly over the past few months. Data from DeFi Pulse shows that over $40 billion in assets has been locked in DeFi protocols. To put things in perspective, that number stood at just $631 million in March 2020. Early investors already made a killing, but there are still opportunities for people to get in on the market and make significant gains.

So, why exactly is DeFi booming all of a sudden?

First and foremost is the fact that the space is still largely unregulated. Financial regulators remain behind the curve, and DeFi has managed to grow in this system.

For instance, platforms will need to ensure that all parties to a transaction are identified appropriately in traditional lending. Lenders will also need to examine a borrower's ability to pay before facilitating a loan. With DeFi, there are no such requirements. Everything relies on the prevalence of trust, and privacy is preserved. There are a few bottlenecks, but the system has managed to work thus far.

For now, regulators are trying to walk a fine line between preserving innovation and protecting investors. Admittedly, DeFi has significant risks that need to be addressed. However, many industry experts tend to just counsel embracing change instead. At the end of the day, DeFi investors are advised to understand the risks involved in the platforms they work with, so they can engage the proper levels of protection.

Another reason for the boom has been the increased embrace from institutional players. Like the traditional crypto market, the DeFi space is getting attention from large financial institutions looking to participate. Their foray into DeFi lends more credence to it, and investors are more comfortable testing out the space for extended periods.

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