The finance world is constantly changing, and DeFi is one of the latest news of the free market. DeFi is an abbreviation of the words Decentralized Finance. This is a set of public services for the distribution of money, shares, and securities. The main feature of DeFi is that everyone who uses cryptocurrencies can enter the service, unlike centralized financial exchanges and markets. Do you want to know how it works?
Read the review that tells you about the following:
- What is the purpose of DeFi
- What decentralized finance implies
- How DeFi let us work with cryptocurrency
- Risks of shared financial services
- FAQ section
Why is there a system of decentralized finance?
DeFi is a relatively new way of working with money since the first DeFi projects for operating with Ethereum cryptocurrency appeared in 2017. The purpose of such products is to give users the freedom to choose the financial system. Decentralization in financial turnover means that there is no heading center that controls the turnover and actions of users. Working with DeFi, anyone can create exchanges, credit companies, and other systems that work independently without external control in the form of the state or the central bank.
DeFi exists in opposition to CeFi. As you may have guessed, these are centralized financial services. Large institutions that have developed in the process of market capitalization show their unproductiveness. CeFi is unprofitable for consumers due to high fees. On another side, it has a large hierarchy of managers, and this system of intermediaries generates corruption and third-party embezzlement. An attempt at total control leads to a lack of control. The result is a money drain. Do you want to know how to manage the finance chain yourself? Read on!
How DeFi works
The financial basis of DeFi is cryptocurrency since this kind of money is not controlled by the government or a single major corporation. Cryptocurrencies, whether Ethereum or Bitcoin, freely circulates around the world. It is enough for the user to have a stable Internet connection to use cryptocurrency as a personal coin, and DeFi lets you take more out of it.
However, money does not exist in isolation from other major market sectors. Digital currency is no exception. People not only make money transfers to each other but also want to sell the money in the same free system – without intermediaries and controlling authority. People want to buy shares of financial institutions and play on the stock exchange on free terms. That’s what DeFi is for. Just as cryptocurrency decentralizes finance, DeFi decentralizes the entire financial system to let users send money via direct transaction.
DeFi is based on three main aspects, namely programming, stable cryptocurrencies, and ways of operating them. Next, you will learn how these systems work together, what legos money is, and what benefits the user receives from value locked in DeFi.
Programming background
To develop a free DeFi, a creator has to have the necessary software conditions and data. It is impossible to run a decentralized finance turnover without a center on any platform, so you need a special infrastructure for product development. It is a great success that today it is no longer necessary to create a program from scratch since technologies offer lending services and apps for the self-development of software.
Ethereum is one of these landing platforms where you can create smart contracts for automatic management of financial services of various kinds. Smart contracts are an automatic code that runs a system for the direction and circulation of cryptocurrencies. Instead of the boss and managers who might be interested in certain development of financial turnover, in Ethereum, you have an independent code. Once you have created a smart contract and completed product development, you no longer interfere in this world. Users manage money with DeFi under once-established and unchangeable rules. Ethereum is the basis for the creation of decentralized finance services such as markets, exchanges, and insurance companies.
Stable currency
This part talks about choosing the right digital money to use in a decentralized finance service. Obviously, if there is no head in our service, then all security and quality of service control are assumed by the smart contracts and the blockchain. It is equally important that the cryptocurrency that is used within DeFi:
- a) is suitable for your automatic code
- b) has a fairly complex programming
- c) has a stable value.
The most common cryptocurrencies are not quite suitable for use in DeFi. The first thing that comes to mind is Bitcoin. This digital money is decentralized, but the programming of Bitcoin protocols is too simple. Thus, Bitcoin program data is incompatible with Ethereum. Simply put, when using Bitcoin, you will not manage to develop smart contracts within such lending platforms as DeFi.
It is logical to think about the Ether, which, of course, is suitable for Ethereum. The disadvantage of ETH is that it is quite volatile. A reliable transaction is only possible with more stable crypto assets. In Defi, a blockchain using ETH is technically possible but not reliable enough for a large number of users who are confident in the purity of each transaction. Thus, the Ethereum blockchain, as well as Bitcoin ones, are not the best option for DeFi. What is needed for pure everlasting blockchain is a stablecoin.
Crypto money is reliable when its value is related to the value of real assets, that is, a real currency – for example, USD. In addition, it must be combined with applications to make lending serviceswork. Where can you get a suitable stablecoin? Well, we have great news – its name is DAI! For use on the DeFi platform, we suggest using stablecoin DAI linked to real finance. This link is very simple and clear because one DAI is equal to one USD. The stability of this digital coin lies in its indirect correlation with the real one. While other coins directly correlate with real assets, there is crypto collateral between the DAI and the USD. These deposits are open for public viewing on the Ethereum platform.
The indirect expression of the DAI in the USD ensures the stability of this coin. To get started, you can use ETH as collateral or just buy DAI directly. The essence of the mediated smart contracts is that even if the price of Ethereum becomes highly mobile, the value of the blocked Ethers with the support of DAI will most likely remain the same thanks to the pledge. Thanks to this blockchain, DAI/ETH is now superior to Bitcoin for working in DeFi.
So, what are the advantages of DAI? Technically, this coin acts as smart contracts on the Ethereum platform, which ensures its compatibility with DeFi. Protecting the DAI from a sharp jump in prices makes this digital money an ideal option for DeFi. It seems that among all projects of digital money, no one is better suited for the turnover of decentralized finance.
Currency exchange method
In order for all this to work, you need reliable applications to use the protocol correctly. There are some services for the free circulation of digital money in decentralized finance. The system offers contracts, then consumers use tokens and start the process of uncontrolled money turnover. These protocols allow users to operate digital assets, that is, to sell, buy, exchange, and trade cryptocurrencies. So, what are the options for someone who wants to successfully use DeFi?
DEX
A decentralized exchange, or DEX for short, allows you to easily withdraw and deposit money into the DeFi. Technically, the exchange is a chain of smart contracts. These smart contracts have the functions of regulating and controlling the turnover of cryptocurrencies. Thus, contracts replace the entire management hierarchy that makes business so difficult. The DEX protocols are based on the Ethereum platform. This ensures a reliable decentralized turnover of funds, as well as harmony with the DAI. You can use any sufficiently powerful device and tokens to launch DEX and transfer USD to DAI for tax-free operation inside the DeFi.
Mining
Users \have access to liquidity mining when their coins are locked for a while and used to provide liquidity in the project. For this purpose, the so-called liquidity pool (asset storage) is used. Since the volume of the value locked up in DeFi projects increases the status of participating protocols and applications, liquidity mining benefits free, decentralized exchanges. The liquidity pool contains two tokens and thus creates a new exchange market for these assets. After sending tokens to the pool, the provider receives special tokens according to the amount of liquidity they have provided. When a transaction occurs, the exchange charges a commission and distributes it among all participants in proportion to their share. So temporarily value locked results in a benefit.
Compound
As growing cryptocurrencies on the stock exchange have become a very popular way to acquire income, these products are becoming increasingly available. A sharp increase in interest in Yield Farming is associated with one of the new protocols on the market – the Compound protocol. Users of this platform can provide loans or borrow in nine different cryptocurrencies, for which they receive project tokens. This app is a platform for connecting borrowers with lenders. It is advantageous that it also works on the basis of Ethereum. Users can take cryptocurrency as collateral and lend it. The compound holds a leading position among the protocols on value locked in the protocol.
This way, you no longer need market makers who charge fees to set up an exchange. All this is now done by the protocols. There is only the headquarters of the creators of applications, protocols, and cryptocurrencies, but not the staff of managers. People both make choices profitable for both parties and avoid the terms of the transaction typical for the market cap. Decentralized applications and networks look like something absolutely fantastic. However, even DeFi is not without risks. Therefore, for the safety of all transactions in the blockchain, users have insurance. How can you ensure your events? Read on to find out!
Money Legos
All the products within DeFi work in combination with each other. People make the combination just as children do the same thing in their constructor. Thus, the composite combinations of DeFi applications received such a name as money legos. Users make convenient or profitable choices, monitor increase or decrease in the value of digital coins, its ratio to USD through applications, and so on.
The lego combination process is a step-by-step chain of choices. A user who has Ethereum finds an exchange with the best exchange rate of Eth for DAI. They then select the most suitable decentralized exchange and conduct the trade. To grow revenue and make a profit from trading on DeFi, users lend DAI to other users at interest. With applications on the DeFi platform, it is also possible to create flash loans that work through a smart contract. Flash loans allow users to borrow funds without any collateral but with a loan repayment within a single transaction. Thus, flash loans allow a person to borrow funds for free until they repay the loan by the end of the same transaction.
So, applications for DeFi allow you to track the value of your assets and operate on them. Using the money legos combination, you can predict yield farming on different landing services. Different protocols allow you to run multiple projects at the same time. Different protocols allow you to manage multiple projects at the same time so that people can conduct content measurement and distribute assets.
What do DeFi users risk?
Since DeFi has only just appeared in the news, some in the field of smart protocols remain untested. Of course, the blockchain allows you to create projects with apps and successfully receive tokens. However, do not forget that smart protocols may not be fully protected from hackers due to the fact that DeFi continues to be developed.
This does not mean that you should abandon the DeFi. You can test all the products that you intend to use in a future experience by attracting a small amount of DAI/ETH. To evaluate how liquidity pools work, try yield farming, and understand DeFi, not so many USD is enough. Combine apps and follow the media news and ads on DeFi that may contain audience insights.
Another important aspect of DeFi is partial decentralization. It is worth remembering that only the core of DeFi, the central component of all platforms, protocols, and apps, is completely decentralized. Other products may be decentralized partially. Therefore, it is necessary to check the nature of the product before investing in the USD and buy tokens. Learn the rules of a certain part of the DeFi where you are going to work.
FAQs
What is the best crypto for DeFi?
It is preferable to choose stable crypto for DeFi. The best crypto is DAI, as it is programmable and quite stable. ETH is also suitable for DeFi, but it is worth remembering that it is more volatile.
What does locking cryptocurrency do?
Crypto value locked up in DeFi allows you to make a turnover and increase the value of the crypto deposit. The income is divided into all participants of the pool. The whole process forms the so-called mining. During that DeFi participants acquire increased profits due to the temporary value locked.
What will happen to DAI if the USD changes?
Since the value of the dollar depends on anything, from international politics to the elections, it is difficult to predict the behavior of crypto by 100%. However, thanks to the method of revaluation of the dollar in the DAI for DeFi, we can talk about its greater stability in comparison with other currencies.
