The moment you are involved in crypto, you will have come across the term "DeFi" often. Indeed, it is a topic that has grown in popularity in recent years. This is partly because of the many new DeFi projects that have been developed. You will be amazed at what the possibilities are with DeFi.
In this article, we explain to you what DeFi (Decentralized Finance) is, as well as how it works. In addition, we will tell you what is possible with DeFi by going deeper into the uses of DeFi.
Table of contents
What is DeFi?
Many financial services and products operate on the centralized model. This means that there is often one company behind them that is eager to make a profit. This company then also determines how the products and services work. For example, data is stored on a central server, which only the company that owns the servers can access.
In 2008, Satoshi Nakamoto thought that could be different. He came up with Bitcoin: a virtual currency that operates on a decentralized network of computers. This was the beginning of the era when currencies no longer needed to be controlled by large central banks. Instead, ordinary people could decide what the operation and future of a currency would look like. This was the very beginning of DeFi.
DeFi stands for Decentralized Finance and is the term used to name all decentralized financial services and services. Virtually any financial product or service can be moved to the blockchain as an application. Actions are fully automated based on inputs.
How does DeFi work?
DeFi can come in many shapes and sizes in practice, but essentially always uses blockchain technology. The blockchain is a way of storing data. A network of thousands of computers are connected together and all contain a copy of historical data. This data is stored in blocks (these can be compared to computer folders containing data) that are connected to each other.
Smart contracts
Different types of data can be stored on the blockchain. Consider transaction data generated when sending cryptocurrencies. It is also possible with some blockchains to store computer code. Users can then execute this code on the blockchain. These are called smart contracts, and are basically digital contracts that provide opportunities for the development of decentralized applications (dApps).
Blockchains that support smart contracts are important to DeFi, although not limited to this. Any blockchain that contributes in some way to the decentralization of finance belongs to DeFi.
There are a number of blockchains that are most important to DeFi, and therefore all offer support for smart contracts:
- Ethereum;
- Solana;
- Avalanche;
- Cardano;
- Terra.
Decentralization
Decentralization is perhaps the most important feature of blockchain technology. The blockchain network consists of thousands of computers connected to each other. They all have a copy of the blockchain's data on their memory. Thus, users are in complete control of the data they generate.
Each user has their own public and private key. With these keys, users can access their data, create data and delete data. The private key is private and only held by the rightful owner. Therefore, no one other than the actual owner can access the data either.
Thus, data generated with DeFi is secure. There is no central party that could sell this data to make a profit on the users of the application developed by this party.
What are the applications of DeFi?
A wide range of financial services and products could work on the blockchain. Therefore, there are also many different applications of DeFi to consider. Below you can see the main applications and functions of DeFi.
Strike
Staking allows you to earn interest on your crypto coins. To do this, you will need to lock your crypto coins into a blockchain that uses Proof of Stake. Blockchains with this consensus mechanism have a network made up of validators. These validators are chosen to be allowed to add new blocks to the blockchain.
To be chosen, validators must pin coins to a blockchain. The higher the number of coins, the higher the chance of being chosen to create a block. You can also stake your coins by outsourcing validation to another validator.
Stablecoins
Stablecoins are crypto coins that always have the same value and is often linked to fiat currencies such as the euro or U.S. dollar. The advantage of stablecoins is that they can be used as protection against high volatility. For example, you can protect profits made with one crypto coin against price declines of other crypto coins against which you would sell the coin.
Also, stablecoins are ideal for use as a means of payment. Suppose you use Bitcoin to buy a product with. By the time the Bitcoin reaches the selling party, it might have already depreciated significantly in value, causing the seller to incur a loss on the sale.
This problem will not occur with stablecoins. Both sender and receiver can assume at all times that the value of the coins sent remains the same.
Exchanges and marketplaces
Cryptocurrencies you can buy from very large well-known central exchanges such as ByBit (international and reliable) and MEXC (Internationally a bit more cowboy, but no KYC needed or just a good and reliable partije from Dutch soil called Finst. Each exchange has its own advantages.
However, these are managed by a central for-profit party. It is also possible to use an exchange managed by the blockchain network. These are called decentralized exchanges, better known as DEXs.
A DEX is an exchange that runs on the blockchain and does not use the traditional order book. Instead, prices are determined automatically and transactions are also automatically executed by smart contracts. Thus, there are no people, companies or organizations involved in the operation of a DEX. Uniswap, Sushiswap and Pancakeswap are well-known examples of DEXs. Read a full article on Decentralized Exchanges here.
On a DEX you can buy crypto coins and tokens, while you can buy other crypto assets on dedicated marketplaces. For example, consider a marketplace for NFTs, of which OpenSea is the best-known example.
Play-to-Earn (P2E) gaming
In recent years, an increasing number of games have been developed for blockchain. In particular, the popularity around Play-to-Earn games has increased. These are games in which users can receive tokens or NFTs as rewards for completing certain tasks. For example, consider winning a PvP battle.
Users can resell these tokens and NFTs for other crypto tokens or fiat currencies. So in this way, players can make money by playing games that run on the blockchain.
Risks of DeFi
It is not trivial to know what the risks of DeFi are. As with any other technical or financial service or product, you are always at risk of losing data or assets.
DeFi relies on smart contracts. These are pre-programmed applications that cannot be influenced by a central party. It may happen (and it has happened before) that such a smart contract contains a bug or vulnerability. Should something go wrong, the crypto coins stored in the smart contract could be lost. There is then no one to recover the lost coins and tokens. This is because the blockchain is irreversible.
Another risk is the decline in value of crypto assets. Despite the fact that cryptocurrencies, NFTs and other crypto products are mostly in the news for their significant price increases, prices can also fall just as quickly again. It is important to be aware of this so that you do not get into trouble when the value of your portfolio has fallen. Therefore, never invest money that you can't actually afford to lose, and always do proper research on a product before putting money into it.
Conclusion
DeFi stands for Decentralized Finance and is used to describe all decentralized financial services and products. Most financial products and services are traditionally centralized: there is then a company or organization behind them that has control over the operation and execution of the services and products.
Moving these types of products to the blockchain decentralizes them. Everything is then automatically executed and processed by smart contract. The data generated is only accessible to its rightful owner.
There are many different uses for DeFi. Think of strike, which allows you to earn interest or tokens, or stablecoins, which can be user to make payments without loss of value. Even though DeFi is widely used, you always run the risk of losing data or assets. After all, everything is automated with smart contracts, so no one can help when something goes wrong.
Leer meer over de slimme contracten en het verschil tussen dApps en slimme contracten
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