August 20, 2020 |James Messi
A Beginner’s Guide to Defi
What is DeFi?
DeFi refers to a new wave of decentralized financial applications that are being built on top of blockchains like Ethereum. This includes new-age tech like decentralized applications (dApps), smart contracts, blockchains, and digital assets. More specifically, DeFi is a general term used to describe how all of these innovative products work together to transition the lending and borrowing of value to a completely decentralized ecosystem.
The primary objective of DeFi is to build a new financial system that removes traditional barriers that block the masses from engaging with sophisticated financial products and services. Highlighting decentralization, DeFi projects also aim to reduce the dependence on centralized third parties. The prevailing theme of the DeFi ecosystem is to provide a more accessible and transparent global economy.
The Benefits of Defi
DeFi is aiming to build a more open financial system by incorporating many benefits into the industry. These benefits include:
- Decentralization and permissionless access
- Borderless engagement between network participants
Decentralized and Permissionless
Defi maintains several advantages over traditional financial products and services. The biggest advantage is removing any need to trust a third party such as a bank or arbitrator who may take control of or make a claim to one’s funds when lending or borrowing money. Removing the reliance on financial institutions also removes many barriers faced when trying to engage with organizations like banks or credit unions. In order to borrow or lend with these businesses, one needs to meet a high standard in terms of creditworthiness and may not be able to access these financial vehicles at all.
With DeFi, one does not need a bank’s permission to get a loan or earn interest on funds personally lent. DeFi is freely accessible to anyone with an internet connection and a small amount of cryptocurrency. Thus it forwards one of the crypto community’s most important goals – banking the unbanked. Enabling billions of people to access financial services that were previously unavailable can significantly augment the overall standard of living.
Bitcoin was the first protocol to bring truly borderless value transfers to the world. DeFi has gone beyond transferring value across borders by allowing users to lend, borrow, or exchange value with people located in any country. Such openness will likely lead to more competitive financial products as banks and credit unions are no longer competing only amongst themselves. As people learn that DeFi products provide higher returns on their savings, it will lead to an increase in demand for these products, and by extension, a more competitive, affordable, and accessible worldwide financial system.
Anyone who experienced the 2008 global financial crisis has a sufficient understanding of how far south things can turn when vital financial data is being hidden, obscured, or manipulated. In more than a few ways, we are still paying for shady dealings by the world’s largest financial institutions. A long-touted benefit of Blockchain technology is that it is based on fully transparent protocols. DeFi simply leverages blockchain technology to add transparency to the services under its umbrella. When every transaction, interest payment, or trade can be viewed by the public we can identify potential issues in advance and make programmatic changes to avoid any financial calamities. As the open-source movement eloquently states it, “Given enough eyeballs, all bugs are shallow.” A fully transparent financial system encourages the same level of problem-solving power.
Use Cases of Defi
The core use-case of DeFi is the category of services that facilitate open borrowing and lending. Open refers to the permissionless nature of these protocols. As mentioned before, someone who needs a loan can get the funds they need instantly with no credit check. On the other hand, those who wish to earn interest on their savings don’t need to write a complex contract and work with intermediaries and attorneys. With DeFi, you can lend out your money across many supported decentralized applications (dApps) and receive interest that is 10 to 50 times higher than that of a standard bank account.
The top ten DeFi assets by market capitalization
In summary, DeFi makes borrowing easier, cheaper, and faster while making lending safer and more rewarding. DeFi use-cases extend beyond borrowing and lending to applications that maintain decentralized markets. An example of this would be a standard decentralized exchange (DEX) which enables traders to swap their digital assets without relying on any trusted third party. Like most blockchains, these platforms are maintained by a network of computers that execute code in order to verify every trade and maintain a high level of security and transparency.
Risks of DeFi
While DeFi has many benefits over the legacy financial system, there are still some risks that are important to consider before diving in headfirst. The biggest risks in DeFi stem from human error and hackers.
In theory, a string of code is infinitely more trustworthy and reliable than any human. That being said, the code behind a smart contract is still produced and reviewed by humans. This leaves a small window of uncertainty as any smart contract may contain a fatal bug that disrupts value from being transferred fairly within a smart contract. This is still advantageous relative to legacy systems as the code is generally available and can be picked apart by anyone well in advance of the issue becoming catastrophic. In the legacy financial world, fatal bugs often are not unearthed until the wreckage forensics.
While honest actors are reviewing code to make sure there are no vulnerabilities, malicious hackers are often waiting to capitalize on these programmatic flaws. To date, millions of dollars have been stolen from DeFi smart contracts by hackers who were one step ahead of the engineers and security auditors behind DeFi projects. It is imperative that these risks are taken into account before putting funds into a DeFi project.
Beaxy Exchange supports the work of DeFi projects that are building a truly free financial system. By removing financial and bureaucratic barriers for billions of people and adding transparency to the aspects of banking that need it the most, DeFi projects are living up to the core values of cryptocurrency. At Beaxy Exchange, we are very excited to see what is next in store for this growing segment of the digital finance industry. Follow us on Twitter and join our Telegram group to stay up-to-date on Beaxy and learn more about the DeFi projects that we are working with.