What is DeFi: The Basics
To start things off, it’s probably worth addressing the core question, before we continue with some of the more-advanced stuff.
So, then – what is DeFi crypto?
The acronym “DeFi” stands for decentralized finance. As the term might imply, it’s a sort of umbrella for a whole huge financial infrastructure that places an emphasis on decentralization.
This decentralization doesn’t just come out of anywhere, though – instead, DeFi is closely related to cryptocurrencies, or rather, the blockchain technology behind crypto.
Blockchains are, primarily, decentralized. Yes, there are exceptions, but for the sake of keeping things simple and confusion-free, let’s paint some things with a broad brush.
Being decentralized means that the blockchain is able to function without a middleman. In regards to finance, that middleman can be anything or anyone – a bank, an individual acting as an escrow, a developer who’s written code for the dApp (more on those later) that you’re using, and so on.
Following that train of thought, the main benefit of DeFi is the fact that it allows for trustless financial processes to take place within its ecosystem. Let me give you an example so that you’d know what I’m talking about:
Imagine that there’s an election happening in your country. You need to go out and cast your vote on one of the candidates. Traditionally, you’d do it the old-fashioned way – go to a voting booth, write your vote on a piece of paper, and place it in a collection box.
These votes would then be transported to a set facility, where they would be counted, before the results would be announced.
Do you see the problem here? If not, think about it this way – count all of the different instances where foul play could happen, and where someone could tamper with the votes. Situations like these lead people to research what is DeFi crypto, in the first place.
Now, with a decentralized application (dApp), you would cast your vote in the same manner, but it would be a) recorded instantly, and b) impossible to forge. This is thanks to the innate features of blockchain technology – specifically, the fact that information that’s submitted to the blockchain cannot be altered or tampered with in any way.
This is actually where Ethereum comes into play, as well.
Ethereum – The Leader in the DeFi Space
Ethereum is one of the largest cryptocurrencies on the market. More specifically, it’s constantly competing with Bitcoin for being the largest crypto project, in general – some enthusiasts believe that it’s only a matter of time until the former surpasses the latter.
There are many reasons for why Ethereum is as popular as it is – the fact that it’s the primary blockchain for all things DeFi is one of them.
The vast majority of DeFi projects that you’ll see on the market are built on Ethereum. Currently, there are also other blockchains that are viable for such endeavors, too – while learning what is DeFi, you might encounter projects built on Polygon, EOS, or TRON. Still, though – Ethereum remains the undisputed leader.
There are multiple reasons for why that’s the case, but the main one is that Ethereum was the launchpad of smart contracts. This is the core tool behind anything related to DeFi.
A smart contract is an agreement that has been coded into the blockchain. This is, evidently, a very primitive way of looking at it, but the core concept is just that. The main feature that makes these contracts appealing, though, is the fact that they are practically impossible to be breached – once a contract is submitted to the blockchain, there’s no turning back, and no way to reverse it or change its settings.
Thanks to smart contracts, you are able to use a DeFi application that’s completely trustless, and does not have any third-party interference – whether it be lending, gambling, or anything related to NFTs, you’re able to use the dApp and rest assured that there’s no foul play involved (if the dApps is actually legitimate, of course!).
Types of DeFi Applications
In the above-located chapter in this “What is DeFi Crypto?” guide, I’ve mentioned a few different concepts, such as NFTs, lending platforms, and so on. These are but a couple of examples of what a DeFi project can look like.
Now, though, it’s worth taking a look at some of the most popular DeFi project types, so you could have a general idea of what to expect from within the space.
- Stablecoins. If you’ve had any prior dealing with cryptocurrencies or crypto-related projects, in general, the term “stablecoin” might be familiar to you. A stablecoin is simply a cryptocurrency that’s price is pegged to (and often backed by) the United States dollar. Meaning, 1 stablecoins will always be worth $1. Stablecoins are used in multiple different DeFi ventures, and they are considered to be DeFi projects themselves, too.
- Lending / Borrowing dApps. These projects work in the same manner as traditional credit institutions, with the main difference being the fact that they do not have an intermediary. You can borrow assets by using your cryptocurrencies (usually – Ether or a stablecoin) as collateral, or lend crypto and earn interest over time.
- Yield Farms. A yield farm is a DeFi venture where you’d invest (stake) some of your crypto assets, and then receive passive yield in return. As of late, these types of dApps have become very popular, on all of the different blockchains that are used in DeFi (mainly on Ethereum and TRON, though).
- Decentralized Exchanges. If you’ve ever used Uniswap before, you probably know what a DEX – decentralized exchange – is. These are crypto exchanges that do not require for you to pass KYC verification checks, and allow trading cryptocurrencies in an anonymous manner.
- Gambling dApps. If you’re looking to find out what is DeFi in order to learn whether or not your favorite gambling dApp falls under the umbrella of DeFi, you’re in luck – it does. Many gambling projects claim to be trustless, and allow users to gamble their assets in a decentralized, anonymous, and transparent manner.
- Wrapped Coins. This is likely one of the more-intricate aspects of DeFi. In layman’s terms, a wrapped coin can be used (sent, received, transacted with, etc.) on a different blockchain than its own one. So, for example, wrapped ADA coins could be used on Ethereum, and would still retain their price values of the actual, original ADA coins.
The aforementioned example of DeFi being used in some important elections is also a category within the space, usually referred to as a “prediction market”. On top of that, naturally, there are many more decentralized finance-related ventures and projects out there – seen above are simply among the more-popular and more-often-encountered ones.
DeFi’s Claim to Fame
While learning all about DeFi – what is DeFi, where it’s used, what are the main types of dApps available, etc. -, you might find yourself wondering about the popularity aspect of the space.
More specifically, how did DeFi go from a niche concept, all the way to becoming an industry-shaking revolution of finance?
Good question! One thing’s for certain – it didn’t happen overnight.
The core elements of the concept of decentralized finance were introduced with the creation of Bitcoin, all the way back in 2009. BTC helped remove the middleman – say, a bank – from the connection you’d have with your money. DeFi does the same thing, except instead of money, it’s often some sort of financial tool.
Not many individuals were wondering how to invest in DeFi until around 2018. Sure, the space had its share of fans and enthusiasts, but the true rise in DeFi projects and their use began together with the increasing popularity of cryptocurrencies worldwide.
The variety of DeFi applications is a huge factor in regards to the popularity of the concept, as well. If it were only stablecoins or lending platforms, chances are that DeFi wouldn’t be where it is today. On the flip side, the fact that it’s as approachable and varied as it is invites a lot of potential new users and investors to the space.
From that point onwards, it’s a cyclical process – more people come into the space, thus the DeFi sector continues booming, thus new people become interested in how to invest in DeFi, thus they start coming into the space.
As time goes on, though, there are new and up-and-coming projects, new dApps, and new DeFi ideas coming up. The space is still relatively new, and many enthusiasts speculate that, while you’re learning what is DeFi crypto, the sector, as a whole, will continue to grow and develop.
Regulations – The End of DeFi?
Whilst you’re learning what is DeFi, one of the bigger subtopics that you may come across has to do with regulations in the space. The general sentiment online is that they’re going to be really bad news for decentralized finance.
Why is that the case? Well, it’s in the name, really.
Regulations have always been a “hot topic” in the crypto space. As time goes on, it would seem that they’re becoming a more and more prominent issue, and governments around the world are slowly, but surely employing them.
Just look at China, as an example. The Chinese government has banned any and all new cryptocurrency-related projects, and while the country aims to issue a digital currency of their own, decentralized cryptos are now banned there.
The US is turning towards the crypto space, as well. While there are struggles in passing crypto-related bills, it would seem that some sort of regulatory crackdown is inevitable.