There’s a lot of uncertainty in the overall global economy right now, plus volatility in the traditional stock market. What’s going on in the larger economy could have some investors looking for alternative investments or new places to put their money.
That could lead them to decentralized finance or DeFi.
Investing in DeFi can mean you earn interest on your crypto holdings with an investment account, trade crypto, or simply buy and hold, hoping the value goes up.
Below, we go into more about what decentralized finance is and what its implications are for everyone.
An Overview of DeFi
Decentralized finance is an emerging form of financial technology. The technology is based on secure distributed ledgers, like what cryptocurrencies use. The idea of DeFi is the removal of bank and institutional control over money, financial services, and financial products.
For consumers, there are benefits.
For example, DeFi can eliminate the fees financial institutions and banks charge for using their services.
You can hold your money in a secure digital wallet rather than a bank, and you don’t need approval. You can use DeFi simply by having a connection to the internet. DeFi also allows transferring funds in a matter of minutes or even seconds.
The third party is essentially taken out of the equation with DeFi.
This juxtaposes centralized finance, where a corporation or bank holds your money. The goal of these institutions is to make money.
As we currently know it, the financial system is made up of third parties who facilitate the movement of money between parties, charging fees for these services.
Things that you don’t even think about are costing you money. For example, if you buy something on your credit card, the charge goes from the merchant to a bank. The bank forwards the card details to a credit card network that clears and charges. Payment is requested from your bank.
Your bank approves the charge, sends the approval to the network through the acquiring bank, and then back to the merchant. Every entity that’s part of the process receives payment for its services.
Specifically, DeFi is associated with the Ethereum blockchain and the cryptocurrencies that are built on it.
DeFi allows people, businesses, and merchants to make financial transactions through the use of emerging technology. Anywhere that provides you an internet connection means you can borrow or trade using software that records your financial actions in a database. These are distributed databases.
The entire philosophy of DeFi is to give users control over their money with the use of personal wallets and trading services that meet the needs of individuals.
How Exactly Does DeFi Work?
DeFi uses the same type of blockchain technology as cryptocurrencies.
A blockchain is a distributed, secured ledger or database. There are applications, dApps, that run the blockchain and handle transactions.
A transaction is recorded in a block, which users then verify.
Peer-to-peer financial transactions are where two parties agree on exchanging cryptocurrency for services or goods, with a thirdparty involved.
If you’re using DeFi to get a loan, for example, you use a decentralized financial app, and you provide your lending needs. An algorithm then matches you with a peer that could meet your needs. You agree to the lender’s terms and receive a loan.
The transaction is recorded in the blockchain. You receive the loan after verification through the mechanism of consensus. Then, the lender can start to collect their payments from you at the intervals you agreed on.
If you make a payment using the dApp, it follows the same process, transferring funds to the lender.
What Are the Benefits of DeFi?
There are a lot of benefits to DeFi for people who use it and investors alike. Some of these benefits include:
- The accessibility component is highly appealing to people who use DFi. For example, maybe you can’t open a bank account or get a traditional loan for some reason. If you have internet access, you can access a DeFi platform, though.
- If you’re directly transacting with another party, you’ll have lower fees and higher interest rates. That’s why it’s important for investors to understand DeFi—you can potentially earn quite a bit on your crypto holdings.
- The smart contracts of DeFi are published on a blockchain, as are records of completed transactions. They’re available for anyone to review. Blockchains are immutable. Immutable means they can’t be changed. The transparency and security of blockchain technology are benefits of DeFi, but so is the way your privacy is preserved when using the platforms.
- You aren’t relying on a centralized authority. For everyone who experienced what happened in 2008, that can in and of itself make DeFi worth exploring.
How Can You Invest in DeFi?
If you want to go the simplest route to invest in decentralized finance, you can buy Ether or another coin that uses the technology. That gives you exposure to the industry that is decentralized finance.
You can deposit your crypto holdings with a lending platform directly, which will allow you to earn interest. If you’re willing to deposit your crypto funds for longer terms, you can earn higher interest rates.
You can also choose between a fixed or variable interest rate.
There’s another way to invest called yield farming. The demand for deposits is intense on DeFi platforms. As a result, yield farming has become popular. With yield farming, you deposit funds on a platform paying the highest interest rates or maybe some other incentive you’re interested in.
Then you monitor what other platforms are offering. If another platform offers something better, you can move your deposits and make more profits.
The incentives change all the time, so yield farmers move their crypto from platform to platform to take advantage.
Finally, another DeFi term and way to make money is called staking. Staking users will put their funds in a crypto wallet, and then they work on maintaining the operations of the blockchain system. They get a set interest rate in exchange.