Beginners Guide to DeFI (Decentralized Finance)

beginners guide to defi

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The origin of the name Decentralized Finance, DeFi in short, is a very interesting story. In 2018, a group of software developers and entrepreneurs were having a discussion on Telegram suggesting names for the protocol. After a series of innovative names, Decentralized finance, or DeFi, finally made the finale and rose as the world’s most popular financial system. The roots of the network, however, go way back to 2008.

Our beginners guide to DeFi will help you get a better grasp of this interesting concept.

DeFi is now a multibillion-dollar industry just after three years of its baptism. A user with a crypto wallet can perform multiple finance tasks. Over 10 million people have downloaded MetaMask, one of the most popular digital wallets used to gain access to these networks.

Okay, So What is DeFi?

Decentralized finance, or ‘DeFi,’ is a digital network that theoretically eliminates approval by a central bank or government agency for financial transactions. Many consider DeFi to be a guidance system for a new wave of financial services innovation. It has an inextricable link to the blockchain, on which Bitcoin is based. The idea is that no single entity has control over or can alter the transaction ledger. This automated system, built on a blockchain, has the capability of displacing traditional banks. The system is unrestricted and anyone from around the globe can access it with a good internet connection. Also, instead of keeping your money in a bank, you keep it in a secure digital wallet and along with that, you can transfer funds in a matter of seconds with no additional charge as opposed to banks.

One of the primary assets of decentralized finance is, well, decentralization. Take, for example, bitcoin: The original crypto asset is essentially a decentralized ledger (its blockchain), with transactions recorded in databases on numerous computers. That single record (stored across multiple databases) is encrypted, and the computers keep track of each other to ensure it hasn’t been tampered with.

Who created it?

There is no firm date for the birth of decentralized finance that we could agree upon. However, we can start with the initiation of Bitcoin. Satoshi Nakamoto, a pseudonym for the person or a group of people created Bitcoin. To date, the identity is still unknown. The network of Bitcoin is primarily based on decentralization.

After the formation of Bitcoin, a young entrepreneur, Vitalik Buterin at the age of 19 developed Ethereum inspired by the platform. He wrote a white paper outlining an alternative platform to Bitcoin that would allow programmers to create their own apps using an integrated programming language. Thus, Ethereum was born, and it has grown exponentially over the last nine years. Many of the cryptocurrencies use the ERC-20 standard to run on the network, which is by far the most popular token. According to price-tracking websites, Ethereum is now the second-largest cryptocurrency, trailing Bitcoin.

To understand decentralized finance and how it works, it is necessary to first understand how it differs from centralized finance. Hence, let us define the two systems separately to have a better grasp of what they each stand for and how they function.

Centralized Finance system

When we say centralized, we generally mean banks that hold your money for safekeeping. In this process, the bank acts as a third party that charges fees for their services such as money transfer from one account to another. Consider all the online payments you have made over the years or even a better example, the credit card. Bank makes money through our savings or payments we make, mostly online. Almost all financial transactions are costly and on top of that, services are slow.

When we compare with decentralized finance, centralization might seem like a better option in terms of safety. People prefer the old ways of trading better than the new digital form, mostly because they are not aware of it and trained to use the system. Time can only decide who will reign the finance territory.

beginners guide to DeFiA guide to Decentralized Finance

The Decentralized Finance protocol

As for decentralized finance, it eliminates the need for intermediaries such as banks. This allows individuals globally to perform financial transactions using the technology, either for personal or business purposes. It follows a peer-to-peer protocol to complete the transaction.

You can move the asset around anywhere in the world if you have an internet connection. The blockchain records and verifies each financial transaction and is not easily hackable. It is an open digital marketplace where you can trade for free. Also, it doesn’t require any paperwork as opposed to the banks that involve long hours of working out the papers to acquire any of the services such as account opening, loan, and many others.

What is the difference between DeFi and cryptos such as Bitcoin and Ethereum?

Bitcoin is a decentralized modern digital currency that functions on its individual blockchain network. It is primarily used as a store of value. Similarly, Ethereum is also a decentralized, open-source blockchain and a foundation for smart contracts. It is a technology that supports digital currency, global payments, and various applications.

On the other hand, DeFi refers to financial services built on public blockchains such as Bitcoin and Ethereum. It allows users to earn interest or borrow against their cryptocurrency holdings. DeFi is made up of a number of applications that revolve around financial services.

How does DeFi work?

DeFi provides financial services using cryptocurrencies and smart contracts, without the need for intermediaries such as banks. The code is visible to anyone for review and hence it is a transparent system. DeFi surpasses geographical boundaries, thus allowing people to make transactions from anywhere around the world.

Users use dApps, the majority of which can be found on the Ethereum network, to facilitate peer-to-peer business transactions. Coins such as Ether, Polkadot (view our Polkadot article here), Solana; Stablecoins; tokens; digital wallets such as Coinbase, MetaMask; are among the more prominent dApps built on the basis of smart contracts.

If you are looking for defi options then here are a few of my favorite exchanges that can be used in the US as well. All these exchanges are trustworthy, easy to use, and have lower fees than other exchanges:

  1. Uphold Exchange – able to earn crypto rewards
  2. FTX US – 5% discount on all trades with this link
  3. eToro – $50 bonus with minimum deposit

As of this writing we would recommend Uphold exchange as the best overall exchange.

What can you do with DeFi?

As previously stated, DeFi provides financial services without the involvement of banks by utilizing cryptocurrencies and smart contracts. The possibilities for what you can do with DeFi continue to expand with the addition of more dApps. One can lend money, make trades, receive a loan instantly, save crypto coins or tokens and earn a higher interest rate as compared to what a bank provides. It also has the provision for purchasing derivatives such as stock options and futures contracts.