The R Roundup Presents: DEFI 101 FOR DUMMIES
With the emphasis of DeFi having such an importance on the future of finance, it is only right our team collate an overview and introduction into the world of decentralisation.
It is important to remember all of our content is purely for entertainment and educational purposes only. At no point should any of this article be regarded as financial advice.
What Is DeFi?
DeFi or Decentralised Finance refers to financial ecosystems on the blockchain that are not run by a centralised organisation or entity. Traditional Finance has always been controlled by a centralised organisation that controls money flow, such as a bank.
Furthermore, within traditional finance, a lot of friction is present between any transaction. Transactions have to go between two middlemen (senders&recipients bank) and an additional payment channel.
This makes traditional finance expensive, so not only is money flow controlled but there are also high costs. DeFi revolutionises the financial sector, allowing peer-to-peer (P2P) transactions and eliminating third-party control and intermediaries from the process.
How Does DeFi Work?
DeFi works via dApps on the blockchain, which uses a decentralised network and smart contracts to automate financial services/processes.
DeFi projects rules and regulations are all set in code which is not changeable (unless the contract is an upgradable contract — which can also be seen within the code). DeFi skips out on intermediaries, such as banks, thus providing improved access to financial services and removing friction for financial processes.
Why DeFi?
DeFi provides us with many use cases and benefits which can aid to the improvement of our day to day lives:
Firstly, DeFi provides accessibility of financial accounts to underbanked populations or people who do not have access to traditional banking services. This allows people to store funds and send funds securely.
Next, DeFi facilitates stable coins; tokens pegged to a stable asset or basket of assets. They allow holders to preserve savings against hyperinflation; they can also be considered the backbone of Defi, enabling DeFi services, such as lending & borrowing. Venezuela is a prime example that displays these benefits. Reserve Protocol has gained popularity in Venezuela due to the lack of access to banking services for the public and hyperinflation present.
Decentralised Exchanges (DEXes) provide the following use case of DeFi. Decentralised Exchanges have four main advantages:
- Unlike centralised exchanges, DEXes allow you to maintain control of your funds. You do not need to transfer between trading, main or futures accounts and the funds are not controlled by a central entity.
- Another advantage of DEXes is that they are anonymous, with no KYC, unlike centralised exchanges ensuring privacy for all users.
- DEXes provide more options as more crypto pairs are available to trade. Uniswap V2 has over 1000 projects available to purchase compared to Coinbase, which allows users to buy around 110 different cryptos.
- DEXes run on rules and automation set via smart contracts and do not need to maintain infrastructure, reducing costs.
The subsequent use case of Defi is P2P Lending and Borrowing**.** Lending & Borrowing (L&B) is a pillar of finance in the world, playing a crucial role in how financial systems work. P2P L&B within DeFi uses smart contracts and cryptography to eliminate intermediaries such as banks or loan companies from the process.
Furthermore, individuals can lend their crypto, allowing others to borrow while still maintaining custody over their assets. Transactions are protected due to smart contract obligations, and the process of L&B is faster with reduced costs for borrowers and greater rewards for Lenders within DeFi.
In addition to this, as smart contracts dictate conditions for L&B, as long as conditions are met, a loan cannot be denied due to human bias, making loans available to anybody who can meet the conditions required.
Furthermore, DeFi can streamline the insurance industry. Smart contracts can be utilised instead of needing insurance companies to provide insurance. Smart contracts ensure payout for insurance if a particular set of pre-programmed rules are used. Smart contracts also allow for predetermined rules which dictate payout levels and costs of insurance, thanks to everything being decided by code. Real-world conditions can also be used to dictate payout, thanks to Crypto Oracles. Oracles are projects such as ChainLink that bridge real-world info onto the blockchain. This means human bias is removed from the insurance business and makes insurance cheaper for individuals hoping to pay for insurance.
The final benefit of DeFi I will go over is that it facilitates Decentralised Autonomous Organisations (DAOs). DAOs have rules and governance set in code through transparent smart contracts. A central authority does not influence DAO’s, which are controlled by automation and crowdsourced process’ instead. This reduces organisational friction and makes governance fully democratic. There is no board of directors or management, with the DAO members allowed to make decisions.
Some concerns surround DeFi; these include potential hacks and exploitation of bugs in smart contracts and scamming being popular in the space due to anonymity. Goldman Sachs has noticed that DeFi provides benefits but acknowledges these potential concerns. “DeFi is easier to access for underbanked populations and provides faster settlements for users, but it’s still a work in progress with flaws like hacks, bugs and “outright scams,” the report by Zach Pandl, co-head of foreign exchange strategy for Goldman Sachs Research, and Isabella Rosenberg, a foreign exchange analyst at Goldman Sachs, said.
As DeFi develops and technologies improve, these are issues that can be resolved. DeFi will become more secure from hacks and bugs due to improved coding and network security. Furthermore, as people become more aware of the potential scams and what to look out for, scamming will become less prevalent within the space.
Overall, it is clear that DeFi provides us with many benefits. It has already begun to revolutionise the world of finance, and we are only witnessing the beginning.
As a reminder this is not a trading signal, it is an opinion and each trader/investor should know and understand the risks attached with trading. At no point should this be regarded as financial advice.
Additional links:
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