Read this article to find out about DeFi or decentralized finance, including its relationship to cryptocurrencies and reliability.
Launched in 2009 with Bitcoin, decentralized finance or "DeFi" has become popular among financial players. It has grown steadily in volume from $15 billion at the beginning of the year to around $80 billion.
DeFi is of interest to a wide range of entrepreneurs, from traditional investors to engineers. This craze explains the appearance of new applications made for the network.
The word "DeFi" comes from the combination of two words: decentralized and finance. Finance refers directly to the classic financial products such as the sale of currency, credits, and insurance among others.
The word decentralized on the other hand is characteristic of blockchain. The word refers to the possibility for users to make transactions directly without the intervention of traditional intermediaries (such as banks and insurance companies). Users can also consult data in a transparent manner.
Users must, however, use a decentralized currency to be able to make online transactions. The main one is Ethereum technology, which offers the advantage of creating several financial applications, such as Maker.
DeFi is part of cryptocurrency and blockchain technology, but with its own characteristics.
While bitcoin is primarily a means of payment, decentralized finance offers you other services, including:
Despite this, DeFi is different from the classic system. Unlike banking and financial institutions, DeFi is digital. All transactions are done entirely online.
DeFi is decentralized, as exchanges are made directly between users, without the intermediary of a bank.
Finally, DeFi is accessible to all. Users do not need to have a bank account.
In short, DeFi is a digital tool that offers the services of traditional banking systems. Indeed, it allows users to:
Obviously, these services already exist in the traditional system, but are less flexible.
First, note that the classical definition of money is also valid for decentralized money. Indeed, the latter can also serve as a means of payment and exchange.
The difference lies in the use of blockchain. Just like cryptocurrencies, decentralized currency is based on blockchain technology. It works in a decentralized way by ignoring traditional mechanisms. It assumes the non-existence of an authority in charge of issuing, controlling or regulating currencies. Moreover, no entity intervenes to guarantee the transactions.
How can you guarantee the security of transactions ? The blockchain ensures the reliability of exchanges by allowing you to store or transmit all information related to transactions. This information is unfalsifiable and unchangeable. These are secured by mining. As a reminder, mining is a technique that ensures the circulation of currencies. Miners perform mathematical calculations to protect the data.
Decentralized currency or cryptocurrency is virtual. It is held in a digital wallet that only you have the code for. Currently, the most famous is Bitcoin. It is a virtual currency created in 2009 that serves only as a means of payment.
In the decentralized finance sector, you use a decentralized currency, the most popular of which is the "ether", also known as "Ethereum" within the community.
Even if the use of decentralized finance is within the reach of all users, it must nevertheless follow certain steps:
Before investing in decentralized finance, you will need ether (the currency used) and a wallet. To buy some, go to a centralized crypto exchange, such as Kraken or Coinbase. These exchanges convert your currencies into cryptocurrencies.
Obviously, you can use other cryptocurrencies offered by some blockchains, like Binance Smart Chain, Polkadot or Cosmos.
The second thing to do is to create an Ethereum wallet. This blockchain protocol imagined by Vitalik Buterin, a Russian-Canadian developer, helps you develop decentralized applications in all types of sectors (such as real estate or insurance).
For the creation, you have the choice between:
In any case, your preference depends on your use case. Metamask is the best choice if you invest via the web or a PC, while Argent is good for mobile use.
Once your wallet is created, all you have to do is transfer ether (the cryptocurrency used by Ethereum) or other virtual currencies into your account. This storage gives you the ability to make multiple transactions.
With your funds, you can now carry out the financial transactions of your choice via the relevant apps, such as:
There are other applications that can help you make transactions.
The last step is to manage your decentralized currencies. This time, arm yourself with good apps like Zapper or Zerion. These tools effectively track all your transactions ranging from lending to borrowing. These also help you manage your decentralized investments properly on your smartphone.
Decentralized finance is an excellent alternative to the traditional financial system. Indeed, it provides innovative and more accessible services.
Ethereum smart contracts are similar to the traditional version. But unlike its precursors, they are governed by computer code. Smart contracts use blockchain technology to secure the terms. Indeed, you have the possibility to read them or to ensure the execution. In addition, beyond lower costs (because they do not require a middleman), this type of contract is easy to access, which limits misinterpretations.
One of the benefits of decentralized finance is governance tokens. This is a token that gives you a vote on changes to smart contracts. Sometimes, you will also be entitled to dividends on the fees of a protocol, or any other form of decentralized investment.
There are several governance tokens, the most important of which are:
In any case, you can inquire about other governance tokens adapted to your profile.
The main advantage of DeFi is its accessibility. Any user with internet access can invest, unlike the traditional system which usually has some conditions. Indeed, decentralized finance is accessible to individuals, investors, professionals and traders.
As more and more users become interested in DeFi, some mainstream institutions are trying to adapt to it. Take the example of the company "Aave" in the UK, which has introduced the EMI license. Its aim is to combine the traditional system with DeFi by allowing users to make digital transactions with traditional currencies.
Apart from its accessibility, smart contracts and token governance, DeFi also has the advantage of being spontaneous. While online transactions require the intervention of an intermediary (such as a broker or agent), this is not the case with decentralized finance. Users, whatever their status, can participate directly in exchanges.
Despite its advantages, decentralized finance has some disadvantages. These generally relate to banking.
The absence of regulation and centralization remains for the moment the main advantage of DeFi. However, in the future, this may become a disadvantage, particularly with regards to certain operations. For example, although Aave has been licensed by the FCA, it has difficulty in operationalising some of its services.
The strong craze for decentralized finance is not without impact on blockchain fees. In fact, its success has caused fees to rise by more than 1,770% in a year.
Obviously, this increase in transaction costs has an impact on the accessibility of decentralised finance, which is becoming:
In any case, despite its drawbacks, decentralized finance is still within the reach of any investor.
As the name suggests, DeFi creates a decentralized system without a regulatory authority. This means that users are responsible for the financial products created or used. Of course, in case of damage, they are obliged to compensate the victims.
However, it is possible to limit this type of risk by making transactions with the creators of DeFi's platforms. In this case, the responsibility in case of a problem lies with the creator organisations.
Let's take the example of the creator of EtherDelta, who was sued in 2018 by the SEC (the American market surveillance authority) because of a problem on the platform.
