DEFI which stands for decentralized finance is an umbrella term for cryptocurrencies in general which draws it’s inspiration from technologies like blockchain and bitcoin, blockchain which is tyhe technology that supports cryptocurrencies and other decentralized digital currencies.
Bitcoin and many other digital-native assets stand out from legacy digital payment methods, such as those run by Visa and PayPal, in that they remove all middlemen from transactions. When you pay with a credit card for coffee at a cafe, a financial institution sits between you and the business, with control over the transaction, retaining the authority to stop or pause it and record it in its private ledger. With bitcoin, those institutions are cut out of the picture.
DeFI and Ethreum.
Most times apps built on the Ethreum network which is the world’s second largest blockchain after Bitcoin are the ones always referred to as Defi this is because it’s easier to use to build other types of decentralized applications beyond simple transactions.
These more complex financial use cases were even highlighted by Ethereum creator Vitalik Buterin back in 2013 in the original Ethereum white paper.
That’s because of Ethereum’s platform for smart contracts – which automatically execute transactions if certain conditions are met – offers much more flexibility. Ethereum programming languages, such as Solidity, are specifically designed for creating and deploying such smart contracts.
For example, say a user wants his or her money to be sent to a friend next Tuesday, but only if the day is sunny in her location according to weather.com. Such rules can be written in a smart contract.
Some of the most popular Defi apps.
- Prediction markets: Markets for betting on the outcome of future events, such as elections. The goal of DeFi versions of prediction markets is to offer the same functionality but without intermediaries.
- Stablecoins: A cryptocurrency that’s tied to an asset outside of cryptocurrency (the dollar or euro, for example) to stabilize the price.
- Decentralized exchanges (DEXs): Online exchanges help users exchange currencies for other currencies, whether U.S. dollars for bitcoin or ether for DAI. DEXs are a hot type of exchange, which connects users directly so they can trade cryptocurrencies with one another without trusting an intermediary with their money.
- Lending platforms: These platforms use smart contracts to replace intermediaries such as banks that manage lending in the middle.
- “Wrapped” bitcoins (WBTC): A way of sending bitcoin to the Ethereum network so the bitcoin can be used directly in Ethereum’s DeFi system. WBTCs allow users to earn interest on the bitcoin they lend out via the decentralized lending platforms described above.
In addition to these apps, new DeFi concepts have sprung up around them:
- Money legos: Putting the concept “composability” another way, DeFi apps are like Legos, the toy blocks children click together to construct buildings, vehicles and so on. DeFi apps can be similarly snapped together like “money legos” to build new financial products.
- Composability: DeFi apps are open source, meaning the code behind them is public for anyone to view. As such, these apps can be used to “compose” new apps with the code as building blocks.
- Liquidity mining: When DeFi applications entice users to their platform by giving them free tokens. This has been the buzziest form of yield farming yet.
- Yield farming: For knowledgeable traders who are willing to take on risk, there’s yield farming, where users scan through various DeFi tokens in search of opportunities for larger returns.
Important Defi FAQs.
How do I make money with DeFi?
The value locked up in Ethereum DeFi projects has been exploding, with many users reportedly making a lot of money.
Using Ethereum-based lending apps, as mentioned above, users can generate “passive income” by loaning out their money and generating interest from the loans. Yield farming, described above, has the potential for even larger returns, but with larger risk. It allows for users to leverage the lending aspect of DeFi to put their crypto assets to work generating the best possible returns. However, these systems tend to be complex and often lack transparency.
Is investing in DeFi safe?
No, it’s risky. Many believe DeFi is the future of finance and that investing in the disruptive technology early could lead to massive gains.
But it’s difficult for newcomers to separate the good projects from the bad. And, there has been plenty of bad.
As DeFi has increased in activity and popularity through 2020, many DeFi applications, such as meme coin YAM, have crashed and burned, sending the market capitalization from $60 million to $0 in 35 minutes. Other DeFi projects, including Hotdog and Pizza, faced the same fate, and many investors lost a lot of money.
In addition, DeFi bugs are unfortunately still very common. Smart contracts are powerful, but they can’t be changed once the rules are baked into the protocol, which often makes bugs permanent and thus increasing risk.