BEGINNER GUIDE TO DECENTRALIZED FINANCE ( DeFi).

Published in

Coinmonks

5 min readFeb 23, 2022

Decentralized finance (DeFi) creates a financial system where people can transfer their funds without any form of intermediary. All activities on Decentralized finance are automated on the blockchain network through a smart contract.

Decentralized applications on DeFi open up various activities for users to benefit from, for example, users can lend and borrow money in the ecosystem without the provision of any sensitive information like KYC. Decentralized exchanges are another function of DeFi, users can swap tokens with other assets with little transaction fees.

WHAT IS DeFi?

Decentralized finance (DeFi) refers to an ecosystem consisting of digital assets, decentralized applications, smart contracts, and protocols that are built on top of a blockchain network.

Decentralized finance aims to create a financial system that is open-source, permissionless, transparent, and available to everyone without the use of intermediaries.

The system makes it possible for buyers, sellers, lenders, and borrowers to interact with the ecosystem through peer-to-peer rather than institutions like banks facilitating the transaction. DeFi also permits users to have full control over their funds which makes it safe and secured from the issue of third parties having access to the funds.

The system is open-source, by this we mean everyone with a wallet and a little funds can interact with the ecosystem. No need to be a millionaire before interaction with the ecosystem and transactions can take place between users across different countries.

The DeFi application covers a wide range of services such as decentralized exchanges (DEXes), NFT industries, betting systems, lending and borrowing, and much more. Decentralized exchanges allow users to swap tokens with other assets with a minimum transaction fee. Centralized exchanges also swap tokens but come with higher fees.

The creation and usage of stablecoin is also the aim of the ecosystem. These coins are pegged to the value of fiat currencies such as the euro, yuan, and dollar. Stablecoins are resistant to rate fluctuation, which makes them suitable for financial transactions on the blockchain. One major example is DAI, it’s issued on the Ethereum blockchain and is pegged to the value of US dollars.

SMART CONTRACT IN DeFi

Decentralized applications work according to how their smart contracts are programmed on top of the blockchain.

Smart contracts are pieces of code running on thousands of computers that are distributed on top of the blockchain. Once deployed on the blockchain, it can only be controlled by the decentralized autonomous organization.

The framework in which DeFi apps work and the execution of transactions between two parties is provided by smart contracts because they encoded activities necessary for the functioning of these services.

WHO INVENTED DeFi?

DeFi was not invented by someone, DeFi apps first appeared on the Ethereum blockchain, which was invented by Vitalik Buterin and since then, they have been spotted on another network that makes use of smart contracts to automate their transactions such as Binance smart chain and Avalanche.

MAIN USE CASE FOR DeFi

Borrowing and lending

If you have cryptocurrency, you can lend it for a return of making a profit on some protocols like Aave or compound. You can also borrow money from this protocol as well, which will require you to deposit some crypto collateral before accessing the borrowed funds.

Most DeFi protocols will require you to deposit more than the amount you are borrowing, to avoid loss when the value of the collateral drops, which may not be of favor to the lenders. But you need to be careful, if the asset value drops too much the protocol can take your collateral to avoid losses.

Since the protocols are built on top of the blockchain, it requires minimum trust between the lender and borrower, in DeFi you are not required to provide any KYC (know your customer) before having access to those services.

Decentralized marketplaces

This is the most important aspect in the DeFi ecosystem, it’s the aspect that gives you access to financial services.

Applications in DeFi such as decentralized exchanges give you room to trade digital assets without the need for an intermediary to hold your funds, trades are made within the user wallet through the help of smart contracts.

Apart from users having full control over their funds, it also brings about low trading fees than centralized exchanges since it requires less maintenance work.

WILL DeFi KILL BANKS?

Traditional banks have access to your money and whenever you want to transfer your money, they help you transfer it on your behalf.

In the DeFi ecosystem, you control your assets by yourself and transfer it anytime you want, you are not required to provide any sensitive information about yourself which is the basic thing when using traditional banks, you will be required to provide KYC, pass a credit check and sometimes prove your income.

Traditional banks are easily hacked which can lead to permanent loss of money. But all these solutions are what the creation of DeFi aims to solve in the future, all funds are secure through blockchain networks.

Age is another barrier in traditional banks, users are required to reach certain ages before having an account with them, DeFi requires no certain age, what you need is a wallet and some funds inside your wallet, with this you can interact with DeFi.

DECENTRALIZED APPLICATION

Aave: this is a decentralized marketplace on the Ethereum network, where you can borrow and lend different types of coins ranging from stablecoin to altcoins.

Aave is the name of the governance token issued by the Aave protocols. Only the Aave holder can govern the protocol.

Uniswap: this is one of the largest cryptocurrencies exchanges on the Ethereum network, they make use of smart contracts to automate all activities.

People can make a profit by providing a liquidity pool to the protocol.

According to the trading volume of 2020, uniswap is the largest cryptocurrency exchange and the most decentralized application among all.

MakerDAO: one of the oldest decentralized exchanges on the Ethereum ecosystem, their major function is the creation of the stablecoin DAI whose value is pegged to the US dollars.

Only the holder of the governance token (MKR) has the voting rights for any changes to be made in the protocol.

CONCLUSION

Decentralized finance (DeFi) has brought about a better and optional way for funds to be secured since every decentralized application is built on top of the blockchain. Users can secure and transfer their funds without the need for an intermediary. People can make money by providing a liquidity pool, borrowing, and lending assets on DeFi applications.