Do you want to learn more about Defi or probably refresh your knowledge on Defi? What do you understand about Defi? Defi or decentralized Finance is a new financial system that’s transparent to everyone and doesn’t require the approval or influence of third-party financial institutions for its operations.
For Defi to work effectively, it needs the operations of cryptography, blockchain and smart contracts. Today, our financial systems operate on a centralized system banks, stock markets, insurance companies and other financial institutions all have someone controlling the system in its services. The centralized financial system comes with risks like mismanagement, fraud, and corruption, just to mention a few. But what if we could have a decentralized financial system that is independent? It doesn’t have to go through any third party? Well, that’s exactly what Defi is all about.
Defi is a term given to financial services that have no central authority or someone in charge using decentralized money like certain cryptocurrencies that can be programmed for automated activities. We can build exchanges, lending services, insurance companies and other organizations that are owned and controlled by anyone. If you’re confused by these terms, you don’t have to worry. I’ll make it simpler and easier for you to understand. In order to create a decentralized financial system, the first thing we need is an infrastructure for programming and running decentralized services. The good thing is Etherium does just that. Ethereum is a do-it-yourself platform for writing decentralized programs, also known as decentralized apps or dapps. Through the use of Etherium, we can write automated code, also known as smart contracts that manage any financial system we’d like to create in a decentralized manner.
This means that we can make the rules as to how a particular service will work. And once we enforce those rules on the Ethereum network, no one will be able to control them. Once we have a system in place like Etherium for creating decentralized apps, we can start building our decentralized financial system. Now, let’s take a look at some of the components of the decentralized system. The first thing any financial system needs is, of course, money and a more stable currency to operate within the system. And this is where Stablecoins come in. Stablecoins are cryptocurrencies that are pegged to the value of a real world asset. Usually some major currencies like the US dollar.
For the purpose of Defi, we need a stablecoin that doesn’t use fiat money reserves like Dai is a decentralized cryptocurrency pegged against the value of the US dollar, meaning one dime equals 1 USD. Unlike the popular stablecoins whose value is backed directly by the US dollar reserves, Dai is backed by cryptocurrency collaterals that can be viewed publicly on the Ethereum blockchain because the AI is over-collateralized. Even if ether’s price becomes extremely volatile, the value of the locked ether backing the DAI circulation will most likely still remain at 100% or more. In essence, the Dai Stablecoin is actually also a smart contract that resides on the Ethereum platform.
This makes the DAI a truly trustless and decentralized stablecoin that cannot be shut down nor censored, and it’s a perfect form of money for other defi services. Now another decentralized financial system has become stable, decentralized money. It’s time to create some additional services. And the first use case that we will discuss is the decentralized exchange or Dex. Dex is operated according to a set of rules or smart contracts that allow users to buy, sell or trade cryptocurrencies just like a DAI. They also reside on the Ethereum platform, which means they operate on a decentralized platform. Meaning when you trade on a Dex, there is nothing like an exchange operator, no sign-ups, no identity verification, and no withdrawal fees. Instead, smart contracts enforce the rules, execute trades and securely handle funds when necessary.
Unlike a centralized system, you don’t have to deposit funds into an exchange account before carrying out a trade, thereby limiting exchange hacking, which is common for all centralized exchanges. Furthermore, we also need to talk about decentralized money markets and services that connect borrowers and lenders on an Ethereum decentralized system. You can lend your crypto out and earn interest on it. Alternatively, when you need money urgently to pay your rent, do some urgent repairs, or need money to buy groceries, and the only funds you have are cryptocurrencies. You can deposit your crypto as collateral, borrow the money and pay it back later. Can you see the beauty of a decentralized system? In addition, we also have the compound platform which automatically connects the lenders with the borrowers and forces the terms of the loans and distributes the interest. The process of earning interest on cryptocurrencies has become extremely popular lately, giving rise to yield farming, a term given to the effort of putting crypto assets to work while seeking to generate the most returns possible. So now we have decentralized stablecoins decentralized exchanges and decentralized money markets.
Can we have decentralized insurance should in case anything goes wrong financially? How about a decentralized platform that connects people who are willing to pay for insurance with people who are willing to insure them for premiums? With a decentralized system, everything is possible without the interference of any insurance company or agent in the middle. Now, you can imagine the advantages that Defi presents, and the advantages are transparency, security, decentralization, free for all services and flexible user experiences, just to mention a few. However, defi comes with some shortcomings and risks.
You should be aware that Defi is still in its early stage, meaning that things can go wrong. We’ve had cases of smart contracts having issues in the past where people didn’t define the rules for certain services correctly and the hackers were able to act on the loopholes and steal people’s money. If you want to try any of the existing defi services, make sure to do it with the amount of money you can afford to lose. In case everything didn’t go as planned. When we say the system is decentralized, it doesn’t mean it won’t encounter some hiccups at the beginning, it’s important to understand exactly how a product or service works before investing in it so you can be aware of any issues that may come up.
In conclusion, the defi revolution has reached the early adopter stage and in the coming years will tell if it will stand the test of time. There’s no doubt that a decentralized financial system can benefit a huge portion of the population that currently suffers from financial discrimination, high fees and inefficiencies and managing their funds. And that takes us to the end of today’s video. I hope you fully understood that Defi is a term given for a variety of decentralized financial services that aim to replace our current centralized financial system.