What is DeFi? Complete Guide for Beginners.
Table of Contents
- 1 In this article, we will tell you what the DeFi ecosystem is, what it is intended for, who uses it, and how you can make money on it.
- 1.1 What is Decentralized Finance (DeFi)?
- 1.2 Why is the DeFi ecosystem needed?
- 1.3 What are the key features and benefits of DeFi?
- 1.4 How and where is DeFi used?
- 1.5 What are the disadvantages and risks of DeFi?
- 1.6 What is Yield Farming?
- 1.7 DeFi sector – useful links
In this article, we will tell you what the DeFi ecosystem is, what it is intended for, who uses it, and how you can make money on it.
What is Decentralized Finance (DeFi)?
Decentralized Finance (DeFi) is a decentralized, open-source, and trustless ecosystem of financial applications/services based on public blockchains, predominantly Ethereum.
The ecosystem encompasses all aspects of financial services and transactions, including lending, loan operations, and trading within decentralized structures. Any Internet user can interact with the ecosystem and manage assets through peer-to-peer (P2P) and decentralized applications (dApps).
Why is the DeFi ecosystem needed?
If Bitcoin is a peer-to-peer electronic money system, then DeFi is a peer-to-peer electronic financial instrument system. The Defi ecosystem can provide anyone with access to traditional financial services, eliminating the need for middlemen and lowering barriers to entry.
What are the key features and benefits of DeFi?
Decentralization and self-government
DeFi lacks centralized governance structures: the rules for conducting business transactions are written in a smart contract. Once the smart contract is up and running, the DeFi app can run on its own with minimal or no human intervention.
The source code of DeFi applications is open to audit, which allows anyone to understand the functionality of the contract or identify bugs. All transactional activity is public – transactions are pseudo-anonymous by default.
Most DeFi applications are available to any internet user.
The DeFi ecosystem is inclusive – anyone can create and use an app. Unlike the traditional financial sector, there are no controllers and accounts that require complex forms to be filled out. Through wallets, users interact directly with smart contracts.
How and where is DeFi used?
Stablecoins are cryptocurrencies whose value is tied to an underlying asset (for example, the US dollar). Stablecoins are backed by fiat currencies, cryptocurrencies (such as ETH), physical assets (such as gold), or a combination of these assets.
Non-custodial landing protocols
One of the popular use cases for DeFi is to obtain loans without the involvement of a trusted party or intermediary such as a bank or corporation.
Non-custodial landing protocols use smart contracts to mitigate counterparty risks and lower transaction costs.
Peer-to-peer prediction markets
Prediction markets are platforms that allow you to bet on the outcome of events, games, elections, and more.
Prediction market platforms and applications rely on the wisdom of the crowd to determine the likelihood of a particular outcome. According to modern scientific research, a large number of people (“crowd”) always predict the consequences of certain events with greater accuracy than individual experts.
Currently, protocols are being created to issue synthetic assets and derivatives through smart contracts.
Platforms for Security Token Offering
The equivalent of the securities market in the DeFi sector is the security token market. STOs imply the issuance of digital assets in full compliance with legal requirements, which provides a higher degree of protection of investor rights and a decrease in regulatory risks for issuers.
Asset management in the DeFi sector is relatively small compared to that in traditional finance. However, several projects are offering decentralized solutions. Its users can manage their own and others’ assets in the form of ETH and ERC-20 tokens.
What are the disadvantages and risks of DeFi?
Systemic risks in the DeFi sector are liquidity and credit risks. Another problem with using cryptocurrencies as collateral is volatility. If the price of underlying assets locked in a CDP falls rapidly, massive asset liquidation occurs and the system may collapse.
The risk of hacking smart contracts
While working with smart contracts eliminates the need for human trust, there remains a need to trust the human-written smart contract code.
Centralizing data flow
Blockchain protocols extract data from the outside world using oracles. If the oracle acts maliciously, the correct execution of the smart contract will be under threat. Centralized data oracles are a vulnerability for DeFi as well. Although decentralized alternatives have already been developed.
Lack of capital in DeFi loans
Despite its merits, loans are inferior to loans in the traditional finance sector. Since the amounts that can be obtained on the appropriate bail are relatively small.
What is Yield Farming?
Yield farming is the process of obtaining native tokens through any form of interaction with DeFi protocols. For example, for providing liquidity to lending protocols or decentralized exchanges (liquidity mining). And also for obtaining loans and participating in voting.
defipulse.com — the number of blocked funds.
defimarketcap.io — market capitalization of tokens.
defiprime.com — interest rates in protocols.
defiscore.io — risk assessment of protocols.
dappradar.com — data on decentralized applications.
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