Defining DeFi
Let’s dip our toes into DeFi
According to Investopedia: “Decentralized finance (DeFi) is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. The system removes the control banks and institutions have on money, financial products, and financial services.”
Okay great - but for most folks, it's probably still unclear what DeFi is and what all the fuss is about.
Simply put - DeFi is financial services on offer on blockchains across the space, such as Ethereum or Polygon. DeFi offers a lot of what traditional banking services offer but often speedier turnarounds and with much higher interest rates. DeFi often uses code instead of a middle person - removing “trust” in a person and allowing code to take on the role that traditional institutions normally take.
Trustless
Let’s take a basic example of a loan in the DeFi world - Mary wants to borrow some money.
Legacy world:
- Mary asks her bank, and her bank asks in return for collateral (something they can take in case she doesn’t pay the loan back) as well as information about her past, her current employment status, where she lives and all sorts of other information.
- Even with all this information, they may still decide not to give her a loan. This all takes time, and when all is worked out it has taken over an hour at the bank office.
DeFi world:
- Mary logs into a DeFi protocol.
- She puts down some cryptocurrency as collateral and borrows money instantly from the protocol (with interest which she can see and agree to).
- The smart contract holds her money as collateral, knows exactly when she put the currency in, and the exact time she needs to pay the loan back (with the agreed interest).
Then, one of 2 things can happen.
- Mary pays back the loan (+ the agreed interest) by the agreed date and receives her collateral back.
or - Mary fails to pay back the loan by the agreed date, and the protocol takes her collateral and gives it to the person loaning her the money.
The DeFi world can be much simpler and faster than the traditional world, allowing secure, peer to peer loans to be agreed to nearly instantly. This is what has drawn so many across the world into the space and why DeFi had such a large amount of money locked into it the past couple of years. But the DeFi space is (like the wider crypto space in general) also fraught with a lot of risk, scams and bugs and should always be approached with caution and research.
Not just loans
DeFi encompasses many services other than loans - much of what drives it is keeping Liquidity in different projects.
But what is Liquidity?
Liquidity is simply having a stock of coins available for folks to trade (rather than being locked away in a wallet). If a project doesn’t have enough “liquid”, trades won’t happen and the project will fail. To remedy this, projects will often incentivize folks to “provide liquidity”, that is, allow their coins to be held in a wider pool of coins for trade, for a time, in return for more coins later, or other rewards.
Projects have gotten extremely creative with this idea and it now permeates everything in the crypto world, from metaverse spaces to games, to NFT art and beyond.
Is the DeFi world for me?
DeFi is a heady topic to get around, but you’ll now at least have some idea of what it is and whether it’s something you’d be interested in learning more about.
Fortunes have been made and lost in the DeFi world so do be careful out there, always do your own research and as always, nothing on Unchained Music is financial advice :)