DeFi - what are decentralized finance and how to use their potential?
If you are interested in cryptocurrencies, sooner or later you will come across the concept of DeFi, i.e. decentralized finance, and you will start to wonder what this term actually means and how it affects the security of your investments.
Term DeFi appeared on the lips of the entire industry last year, but platforms of this type only this year experienced a real siege. For some, a form of quick earnings, for others, a good investment to keep capital during declines in the stock market.
DeFi – what does it actually mean?
Decentralized finance is a form of financial services based on a system of intelligent network of contacts entered in blockchain, which omits the central financial intermediaries, ie. Stock exchanges, brokerage houses or banks. It is based on the peer-to-peer (P2P) model, i.e. a peer-to-peer network in which all users are participants in the system on the same terms.
The DeFi applications themselves mimic the operation of traditional financial systems, i.e. banks and stock exchanges, however, taking investing to a higher level and ensuring anonymity for users, while being completely safe. In the case of decentralized finance, the carrier is cryptocurrencies, with the difference compared to traditional forms of financing that DeFi applications function without a central control exercising control over the entire system.
Thanks to DeFi, users can, for example, borrow a cryptocurrency, as a traditional bank does with a fiat currency, and profit from interest as a lender. In this case, interest rates are usually more attractive than in the case of traditional banks operating under the standard system. In most cases, the only requirement to take out a DeFi loan is that it can be secured with other crypto assets. Users may sometimes offer their NFT or non-redeemable tokens as collateral, but it all depends on the DeFi protocol used.
Despite the expanding possibilities of the application, SWAP, i.e. exchange, remains the most common transaction made by users using DeFi. While there are also many more complex options for their use, such as enabling liquidity maintenance for decentralized cryptocurrency conversion, this transaction still dominates the DeFi exchange allowing users to easily and quickly exchange one cryptocurrency for another without leaving the wallet.
DeFi based on cryptocurrencies, i.e. UNI, YFI, CAKE, XVS, LINK, AAVE, MKR, SUSHI, COMP, REN, SXP and 1INCH have been strengthening their position on the market for some time, presenting themselves as a financial product worth using
Decentralized finances – how to use their potential?
One of the advantages of DeFi is that when you trade, you gain freedom and independence from the oversight of international financial organizations that control the flow of most financial and investment resources. In practice, this means that your personal data remains safe (you remain fully anonymous), and the transaction itself bypasses procedures that are well known to all those who invest using traditional methods.
Despite the fact that DeFi is a fairly new financial product, and in some it still raises some uncertainty, you need to know that the system is constantly improving in order to better protect the resources entrusted to it. However, it is worth remembering that you should take care of the appropriate security of the medium that you use to work with the cryptocurrencies you have purchased and remember to log out of the application after completing your activities in the wallet. This will allow us to invest without worries, because DeFi protocols will ensure the security of our transactions.
When delving into the topic, it is worth paying attention to the fact that as the interest rate increases, the risk associated with the cryptocurrency or cryptocurrency pair increases. Such dependency will not surprise people who have already had experience with investing on conventional exchanges, as similar rules apply to the traditional market. However, inexperienced players can lose a lot if they misallocate their resources.
The possibilities of using DeFi are increasing, but the most popular of them at the moment are investments on DEX, i.e. decentralized stablecoin and cryptocurrency exchanges. DeFi also has its share in the independent loan and credit market. Its potential, however, is mainly determined by the speed, security and anonymity of transactions, which is well known to the owners of virtual wallets that enable the accumulation and exchange of financial assets. DeFi from year nBlockchainand the year grows stronger, replicating well-known financial structures and it is only up to the users how these opportunities will be used in the future.
What are Decentralized Finance based on?
The pillars of the DeFI system are:
a permanent structure in which the records of transactions and events are stored in a distributed manner, without a central unit to control all resources. Each block belonging to the structure is secured with the help of cryptographic functions and is connected with subsequent blocks by transferring data from the previous block. The blocks are also time-stamped, which make it possible to define the moment at which the transaction or event was registered.
- Cryptographic system
encryption, i.e. how the data in the blockchain network is secured against unauthorized access, virtual digital locks are used for this – codes that are known only to insiders (sender and recipient of the cryptocurrency), while preventing access to them third parties or institutions.
- Smart Contract
a smart contract is a type of contract secured by a code stored in a distributed and decentralized blockchain network, which contains the conditions under which the transaction is concluded between the buyer and the seller.code Programming is a guarantee of the operation and ensures its transparency, thanks to which it is possible to track its implementation, which is also important to guarantee its irreversibility. Thanks to such a system, it is possible to carry out trusted transactions in agreement between the parties to the contract without the need for control by any supervisory authority.
- Yield farming
is an additional blockade of cryptocurrencies by liquidity mining providers in smart contracts in order to provide financial liquidity to the DeFI market. This is related to the Automated Market Maker (AMM) which is an integral part of the financial decentralization system. At the time of the exchange, the AMM is based on an asset valuation algorithm. Rewarded with additional profit, higher than LM. It can be compared to a dividend.
quite fast form of exchange based on the contract between users and pools of liquidity on the exchange equal value, which amounts exchange. It works similarly to a currency exchange office, but with the difference that the platform allows you to exchange tokens, provide liquidity or yield farming. Examples of platforms that perform this type of operation are: PancakeSwap, SushiSwap or Uniswap.
is an investment similar to a long-term deposit in which we place owned by yourself cryptocurrency in the digital wallet and we are waiting for the status of validator of the new block, the so-called Proof of Stake . The chances of obtaining it are directly proportional to the amount of funds blocked. What does this mean in practice? This is an option for the patient who want to earn rewards, e.g. in the form of a fixed percentage of the transaction or cryptocurrency.
a decentralized applications (called. Decentralizedapplications),whose operation is based on a network of computer nodes having their own programming language. The blockchain platform is based on a network of smart contracts operating as part of a distributed consensus algorithm – the first of its kind was created by Ethereum (ETH). This algorithm is an element that facilitates the coordination of the entire process and distributed settings – it is a controller of the entire mechanism, an electronic trustee, thanks to which DApps provide the same quality of services as other ordinary applications, while enjoying the advantages of decentralization – resistance to corruption, freedom from censorship and with virtually uninterrupted working time. IMPORTANT: always check the applications you use to be sure that they are completely safe and their operation is transparent.
is a cryptocurrency that has a connection with a traditional currency, which is usually the dollar. In this case, the exchange takes place in a 1: 1 ratio (coin: dollar), we only need a unit that is the emissary of the token and we will be able to do this. Of course, such an exchange can also be made for other cryptocurrencies, but with appropriate security – a financial surplus, which is to protect the finances of the person who makes the exchange.
decentralized exchange, is a place where investors’ keys can be kept during their transactions. It is a solution that enables financial liquidity between contractors. DEX platforms are based on the aforementioned peer-2-peer transactions – automatic, intelligent contacts that allow you to make transactions without an intermediary. IMPORTANT: While part of the DEX works on standard procurement protocols, newer versions rely on exchange and liquidity protocols where developers create and implement modern fund aggregation tools.
- Liquidity mining
a form of providing financial liquidity to a decentralized exchange, involves providing liquidity through cryptocurrencies on decentralized exchanges (DEX) that seek to reward users who want to bring capital to their platform. These activities are supported by an intelligent contract, the Automatic Market Maker (AMM), which regulates trading without the order book of the exchange. Liquid extraction system determines income, where you earn as a user of a decentralized finances (DeFi).
DeFi – some useful tips for beginners
Before you start your adventure with decentralized finance, read a few tips that will help you avoid costly mistakes:
- If you are already thinking about investing, start by verifying the application and the website you are going to use, make sure that that they are safe and transactions made with them are transparent.
- Be careful, always check whether you are on the DEX or its smart copy. If you have doubts or lack of knowledge, use the support of people who have the appropriate skills and take advantage of their experience.
- If you want to operate independently, you can check and obtain reliable information on sites like coinmarketcap.com that have already been tested by millions of users around the world.
- Be vigilant especially when it comes to choosing the cryptocurrency you want to invest in and check its source. Take care of your wallet resources by navigating the world of DeFi only with proven players, and remember hackers never sleep.
- Remember, this is important: When you use a platform for the first time, connect to a new wallet first and check the service for a small amount. When ending your activities on the DEX exchange, always log out of your wallet.
Good luck with your first investments!