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Everything you need to know about decentralized finance

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Everything you need to know about decentralized finance

Decentralized finance (Challenge) is one of the newest buzzwords on the internet, but only a few truly understand what it really means and its implications for the global financial system.

The term was coined in 2018 by a group of Ethereum entrepreneurs and developers who wanted to open financial applications from traditional systems.

Simply put, decentralized finance is an emerging financial technology based on secure distributed ledgers (the technology that tracks all transactions on a given financial platform), similar to those used by cryptocurrencies.

Basically, the system removes the controlling power of banks and institutions over money, financial products and financial services.

Think of this scenario, instead of your bank or debit card issuer being the middleman between you and a vendor when you make a purchase, you use digital currencies like bitcoin and ethereum and have ownership to use them directly.

How DeFi Works

DeFi uses Smart contracts and cryptocurrencies to provide financial services to eliminate the need for intermediaries, such as guarantors.

Crypto Explainer: Everything You Need About Decentralized Finance (DeFi)
DeFi uses smart contracts and cryptography to execute p2p transactions. Image source: Monthly Finances

These services include lending – users can lend their cryptocurrency and earn interest, receive loans, transact peer-to-peer without a broker, save cryptocurrency, and get better interest rates than those offered by traditional banks.

Decentralized Finance users use decentralized applications (DApps) to facilitate business transactions. Some of the widely used services and applications are cryptocurrencies (EtherPolkadot, Solana), stablecoins, digital wallets, liquidity mining, staking, yield farming, and more.

Advantages of DeFi

As more and more DApps continue to enter the system, the possibilities for DeFi continue to grow. A predominant advantage includes sending money anywhere in the world (quickly and inexpensively).

Moreover, with the help of decentralized finance, users can store money using crypto wallets and earn higher returns than one can get in traditional banks. They can also borrow/lend peer-to-peer, trade cryptocurrencies anonymously, and trade tokenized versions of investments such as stocks, funds, and non-fungible tokens (NFT).

Overall, the benefits include lower costs, greater types of services, and the ability to earn higher income from crypto holdings.

Disadvantages of DeFi

Like other emerging financial systems, DeFi has its drawbacks, especially since it is a new technology that aims to disrupt an established institution like centralized banks.

Participating is not as easy as going to a local bank. DeFi can be a challenge for beginners to navigate due to the massive amount of DeFi applications and investment opportunities in the space.

Plus, the process can be confusing. Because, to access the world of DeFi, you will need to move currencies from centralized exchanges like Binance in a non-custodial wallet like Trust Wallet and Metamask. The whole process requires knowledge and care in order not to be mistaken.

Foremost among the disadvantages is the problem of theft and scams. According to blockchain analytics company On-chain analysis in May 2022, of the $1.7 billion in stolen cryptocurrency at that time, 97% came from DeFi protocols.

Crypto Explainer: Everything You Need About Decentralized Finance (DeFi)
Fraud in the DeFi space has been on the rise lately

In these DeFi scams, developers create cryptocurrency projects before stealing investors’ money and disappearing. Chainalysis has warned that many attacks on DeFi exchanges over the past year can be traced to errors in the smart contract code governing these protocols, which hackers exploit to steal funds.

Additionally, many scammers are catching naïve new crypto investors with unreal returns that drastically exceed those offered by traditional financial institutions.

Conclusion

DeFi is a large financial ecosystem that strives to eliminate intermediaries and enable financial transactions between users.

Its supporters and believers say it is the start of a revolution that allows people from all walks of life to participate in financial transactions that would otherwise be inaccessible to them. Critics and naysayers believe that Bitcoin, Ethereum, NFT and all other blockchain-based assets are just fads that will fade into oblivion over time.

Right now, there’s so much hype around the concept. For beginners looking to get started, it’s important to understand not only the benefits but also the risks before getting started.

While the returns offered by DeFi are enticing, be aware of the scams and thefts.


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