Decentralized finance or DeFi is an encompassing term that refers to financial applications in cryptocurrency or blockchain that manage financial transactions. The primary goal of DeFi is to eliminate the need for intermediaries, such as banks, brokers, and exchanges in finance.
Traditional or centralized finance
Centralized systems manage almost every aspect of banking and finance. The policies that these systems operate on come from regulatory bodies like the Federal Reserve and Securities and Exchange Commission in the US. Not all consumers can access banking and financial services-those who live in remote areas or are unemployed, for example.
DeFi democratizes financial processes by eliminating middlemen and empowering ordinary people to lend, borrow, or trade through peer-to-peer exchanges. Without the go-between, transactions are swift and costs are lower because there are no additional fees. Blockchain and cryptocurrency enable DeFi through “smart contracts.” Smart contracts are programs or protocols that are automatically executed when predetermined conditions are met. Right now, most DeFi apps are built on the Ethereum network.
According to Kevin Werbach of Wharton Business School, the three attributes of DeFi are:
• Transactions are completed on a trust-minimized blockchain platform. In blockchain, the term “trust-minimized” is a good thing. Trust is circulated among different people on the blockchain who abide by the rules that are defined by protocols.
• No one takes ownership of investors’ assets.
• DeFi services are open, programmable, and composable.
DeFi applications used today
• Traditional financial transactions, such as payments, trading, lending, and borrowing
• Decentralized exchanges (DEXs)
• E-wallets that operate independently of crypto exchanges
• Stable coins or cryptocurrencies backed by non-crypto assets, such as dollars or euros
• Non-fungible tokens (NFTs)
• Yield harvesting-crypto investors lend their tokens and the DeFi platforms pay them for agreeing to the loan. Investors might earn a profit when the coins paid by the platform appreciates.
• Prediction markets-offer platforms for betting on the outcome of future events without intermediaries
Drawbacks of DeFi
• As DeFi is a software application, it can have issues or bugs that are common to any software.
• DeFi technology is new and has yet to be fully tested at scale over an extended period. Funds may be lost or put at risk.
• No protection for consumers.
• Hackers are also a threat, just like in traditional finance.
• Almost all DeFi lending transactions require collateral equivalent to 100% of the loan value or more.
The future of DeFi
Though DeFi is still in its infancy, the future looks bright, according to Dan Simerman. Dan is the Head of Financial Relations at IOTA foundation, a DeFi research and development group. He says, “The promise is there. It is up to us to continue educating people about the potential, but we also need to keep working hard to build the tools that will allow people to see it for themselves.”
Rutgers Business School states that in the foreseeable future, financial services will run on distributed ledger technology-a decentralized database managed by multiple members with no central administrator. DeFi will enable autonomous products and services. Banks and financial services will be automated. They will be run by codes and algorithms with no human interactions.
Investing in DeFi
There are three common ways of earning through DeFi. You can lend your crypto coins and become a “yield farmer” or receiving governance tokens from the DeFi platform you’re on for lending your coins. The value of these tokens may appreciate. Another way is to put your tokens in a decentralized exchange and earn fees by becoming a market maker. Market making is when a crypto trader provides liquidity to both buyers and sellers. Finally, you can invest in DeFi projects. Before you invest in a DeFi project or use a DeFi app, do your research on the project. Make sure that it has been audited. Know the team who developed it. It is not uncommon for projects to have anonymous teams, but you’ll need to analyze the transparency they offer. You should be able to see what they are currently doing. An authentic community is also a good gauge of a project’s viability. Reviews and feedback from users are also very helpful.
The Monero blockchain does not support DeFi, but you can go into DeFi using XMR. You will need to exchange XMR to a crypto token that’s supported by a DeFi network, such as ethereum. Make sure your Monero tokens are in a secure web-based crypto wallet. Web-based wallets make online crypto transactions more convenient. If you don’t have an online wallet yet, XMRWallet is an open-source Monero wallet that complements the privacy that Monero guarantees. Registration is free when you create an XMRWallet account. You can immediately transfer your XMR once you’ve created your XMRWallet.
Create a crypto wallet acceptable to the DeFi protocols you’re interested in. Fund this wallet by exchanging your XMR to the required token. Once you’ve exchanged your XMR, you can now dive into DeFi.