Decentralised finance or DeFi is an umbrella term for a virtual financial infrastructure that removes regulatory control from government agencies or the central bank to approve financial transactions. DeFi operates through the blockchain, which is a decentralised technology that allows all copies of transactions to be recorded on all computers or nodes. It works with the concept that transactions cannot be controlled by a single entity alone.
DeFi’s financial services could mostly be found on the second largest crypto marketplace called Ethereum. Ethereum also permits the creation of other blockchain apps through the platform. Through decentralised apps (dApps), transactions among two or more parties can happen without involving any third parties. These transactions could involve borrowing, lending, exchanging, and trading cryptocurrencies. Theoretically, dApps is a digital marketplace that is free, fair, and open. However, this does not always happen in the real world.
DeFi versus Bitcoin
Bitcoin is a decentralised cryptocurrency that works through its own blockchain. On the other hand, DeFi is an umbrella of financial services that operate on various blockchains that allow crypto users to borrow or earn interest in their crypto holdings. These financial services that comprise DeFi include borrowing, trading, lending, and derivatives.
DeFi provides financial services by eliminating intermediaries through the use of smart contracts and cryptocurrencies. These services include buying derivatives such as futures contracts and stock options, saving crypto and generating a higher interest rate compared to what is offered by banks, transacting peer-to-peer trades without a broker, obtaining an instant loan, and lending.
Crypto users use dApps to proceed with peer-to-peer business transactions. These apps can mostly be found on the Ethereum network. The most popular dApps and DeFi services include tokens, DeFi mining, digital wallets, trading, coins, borrowing, staking, trading, and saving using smart contracts. The cryptocurrency market is a field of its own. The Bitcoin Motion website discusses more of this.
The open-source nature of DeFi makes its apps and protocols open to be inspected and innovated upon. This results in infinite ways where users can develop their own dApps by combining protocols.
Smart Contract Defined
Smart contracts work as virtual agreements between two parties. A smart contract cannot be altered because it operates on a blockchain and is stored on a public ledger. Smart contracts are processed by blockchain and do not need a third party for sending these. Transactions involving peer-to-peer get closed if and only if the conditions on the agreement are pushed through.
Users can make use of the benefit of smart contracts that allow people to borrow and lend cryptocurrency without intermediaries, which exceeds the risks involved in traditional lending. An example would be that the lender can just take the funds back if the debtor cannot meet their loan obligations. Moreover, DeFi savings accounts work like typical bank savings accounts but with higher interest rates that could pay out the user on a daily, weekly, monthly basis.
There is no lone creator of the idea of decentralised finance. It is said that the pseudonym Satoshi Nakamoto created the first cryptocurrency, Bitcoin. However, it is still unknown up to this day the true identity or identities of Satoshi Nakamoto.
Ethereum was created by Vitalik Buterin. This Russian-Canadian programmer wrote a white paper that describes an alternative platform to Bitcoin that allows app development of other programmers through Ethereum’s built-in programming language. Ethereum has developed into the second-largest cryptocurrency after Bitcoin after nine years of operation.
Money-Making Opportunities in DeFi
There are many ways that crypto users can take advantage of the popularity of DeFi. One method is to generate passive income through the use of lending apps that operate on Ethereum. It works by users who loan their money and earn revenues through the loan interests. Another method is through the use of yield farming, where users check a number of DeFi tokens to seek opportunities for larger revenues. If you are a newbie trader and would like to know more about DeFi, you can learn more from this platform.
Risk Involved in DeFi
DeFi also is risky as it also is with other decentralised blockchain networks that work on cryptocurrency trading. This also goes deeper since this technology produces an imbalance in an established institution such as a centralised bank. This is also risky for newbie traders who think that DeFi is all roses and has no thorns. Despite the security features of Ethereum, it still is exposed to potential risks.
Significant concerns regarding DeFi include crime and fraud. Chainalysis reports that in 2021, $14 billion in cryptocurrency was sent to addresses that are illegal.
In 2021, DeFi protocols were stolen with $2.2 billion by cybercriminals. Analysis shows that victims were robbed with a total of $7.8 billion in cryptocurrency, with $2.8 billion from a rug pull. These scams happen because legitimate cryptocurrency projects are developed before the developers steal the money from investors and disappear. Most DeFi exchange attacks last year were tracked down to errors in the smart contract code that run these protocols, which cybercriminals take advantage of.