I don’t want to make anything seem complicated so I will use simple terms and before I proceed, the information I will be releasing is only for entertainment/educational purposes. Make sure to DO YOUR RESEARCH before applying anything I will say to your finances as I am not responsible for anything that might go wrong.
I would define Decentralized Finance or Defi as a habitat or an ecosystem of financial applications that are built on blockchain and which also rely on smart contracts. This is said to be an updated financial system dominating the previous, Centralized Finance CeFi. Before you proceed to know what Defi is and how this ecosystem works, I would like us to look at this old financial system. Don’t get carried away with the terms I am using that you aren’t familiar with yet as I will break everything down to your understanding.
First of all, the word ‘centralized’ means that something is controlled by someone, hence there is a middle man or third parties involved. Centralized finance is a traditional way of finance whereby orders are controlled by an authority(middle man, third party) with no other competing parties. In this system, you are handing over your finances to be controlled by an authority that can be highly manipulated. We all have been seeing how inflation comes on the fiat we use for our daily needs. Let me explain the smart contract.
I will have to emphasize this using a real-life scenario before I go about defining a smart contract. Take, for instance, I want to buy something from a stranger worth millions of dollars for the first time. There is no trust for one person to first hand over one item trusting that others will deliver because this is the first time doing business. So what will happen in this case? The only way that would seem safe is to provide a third party so we could transact safely. Now imagine I am transacting with a huge amount of money, do you think this so-called third party won’t ask for a fee for making the transaction safe? Another problem right? So here comes a smart contract…
Smart contracts are computer algorithms built to enable two people to exchange anything of value transparently while avoiding the use of a third party. It means I can comfortably send my millions to the smart contract and wait for this other guy to send his goods too to that smart contract. Once the algorithm checks and sees that we both have dropped our goods at the right quantity expected for the swap to occur, it automatically sends my package to me and mine, to the stranger.
Now, let me use a scenario in the crypto space to cite another example. Some airdrops require you to send a specific amount of BNB to the contract address for a specific amount of tokens too, if you don’t send that amount of BNB, in most cases your transaction will fail and you will not receive your tokens. That’s a smart contract at work. Interesting right?
N/B: Gas fees could be in TRX, ETH, BNB, and other major coins that are at the head of their blockchain. However, if you do not know what airdrops are, refer to the video in the link below. You could do that after reading the article.
LINK TO AIRDROP VIDEO
Now you have understood these concepts, read the definition of Decentralized Finance again. Now you’re cleared.
So with all these being said, we have seen that there are numerous advantages of Defi over Cefi.
1. You do not need a central man to do business with anyone from any part of the world.
2. This system can be used by anyone to access Decentralized Applications faster and less expensive. Let me explain the second point.
Now, Binance, Bybit, Okex, and the rest are centralized exchanges even when they are working with blockchain. Do you know why? Because you are still giving your money to CZ (the CEO of Binance) to keep for you for those of us who use Binance. And guess what? Before you use these exchanges, you will have to do the verification. It means people below 18 years are prohibited from using those systems.
So guess what, the likes of UNISWAP, PANCAKESWAP, BAKERYSWAP, and the rest are now Decentralized Exchanges(DEX) that anyone can access and trade crypto effectively without having to go through the stress of setting your profile up or doing KYC(Know Your Customer Verification) before being allowed to use most of its features. All you just need is to have access to the applications used to access them like your trust wallet(a non-exchange wallet) and gas fees(depending on the blockchain). You are starting to see the beauty of Defi, I guess.
Asides from DEX which makes crypto trading easier and accessible to anyone, there are other applications or I should say use cases of Defi.
Borrowing and lending: Defi has made borrowing and lending possible with the help of smart contracts. To borrow, you will need to drop collateral which is usually a digital asset equivalent to the amount (in value) of the crypto you want to borrow. Once you are ready to pay back, you return the borrowed coin usually with interest, and get back your digital asset. Platforms to check for this are AAVE, Compound Finance, dydx. There are still other outstanding ones. Go do some research.
Lock up and Earn: In the traditional system of finance, your government tells you to leave your money in the bank so you earn 2% after how many years? You should leave your hard-earned money for inflation to eat the value up?😂 Please never do that in this age, the crypto and blockchain space has made things better for you. There are lock up and earn systems which is also referred to as staking, here where you can give them your money in USD and earn much higher interest in a shorter time. Compound finance does that too. I don’t know the subheading to give to my next point but follow me as I will tell you a brief story.
Some time ago before I became familiar with the blockchain space, I always wanted to start saving in USD due to the inflation rate on Naira. So I decided that I would create a domiciliary account for that. Long story short, after dedicating time to study the components in the space, I realized that there was something like USDT, a stablecoin that had always taken the dollar value and I could use that to start saving in USD and it would be less expensive than opening a dollar account and even relieving the stress of always having to verify one issue or the other. Now you know you can start saving in USD without having a domiciliary account. The Defi ecosystem has a whole lot in it.
Nevertheless, there is always a downside to everything. Because it’s a relatively new system that is still under development, humans are the ones developing these systems which are prone to errors. There might be bugs in smart contracts. Several events have occurred in which hackers have manipulated these systems to steal people’s private keys which will resolve in loss of funds so be very careful and stay alert so you know how to avoid losing funds when any of these systems are faulty. The best way to stay alert is to below to an active crypto community on the social media platforms you use.
Another common downside is that these crypto-assets can lose their value anytime due to huge sell off of the assets or manipulations from the big players. Network fees too can be an issue. At the time of writing this article, the ETH network fees are overwhelming. Some companies are beginning to migrate to other blockchains with lower gas fees like the Binance Smart chain network and Tron blockchain.
Nevertheless, I am grateful that everyone reading this article, especially the newbies are now familiar with what Defi is, its applications, and the risk involved. I am very optimistic about the future of what the Defi ecosystem holds. I am still following closely and staying updated with the new upgrades that are going on every day in the crypto and blockchain space at large. I have one piece of advice for everyone. Make sure you use the money you can afford to lose to try out these systems. Don’t invest money meant for your basic needs. That’s not advisable. In the meantime, I am signing out here. Thank you for your time.
