If you're involved in the crypto ecosystem in any capacity, then you know how trendy DeFi has been. So long as you have an internet connection, you've likely seen at least one person talk about the benefits and importance of DeFi, also known as decentralized finance.
But how do we define decentralized finance in the crypto world? And how is it different from centralized finance? What advantages are there to being decentralized? We'll answer these questions and others. But let's start with the basics.
Before DeFi became all the rage, CeFi was the king of the crypto market. CeFi, or centralized finance, is the standard for crypto investing and trading. It has long had a stranglehold on the industry’s financial system. With centralized finance, trading and investing in cryptocurrency take place on a central exchange.
When using a centralized cryptocurrency exchange, the user is at the mercy of platform owners who have access to customers’ funds. This includes what financial services the platform offers, what coins and tokens it lists, and customer support methods (most platforms offer help through email or a ticketing system).
Many centralized exchanges focus solely on providing a platform to trade high-market-cap crypto assets like Bitcoin (BTC) and Ethereum (ETH). However, many other exchanges offer unique financial products like staking, margin trading, lending, and borrowing.
Most people currently involved with crypto trading or investing probably use a CeFi platform like Binance or Coinbase. Some of the more popular reasons users like centralized exchanges include the following:
Centralized platforms, like banks and other financial institutions, are centrally controlled. As a result, they are often considered more reliable and stable than their decentralized counterparts. However, this isn’t always the case, since centralized services are susceptible to fraudulent behavior, forgeries, and other questionable actions that can prove challenging to trace or validate.
Since CeFi is custodial, users typically have to verify their identity, which means anonymity has to be sacrificed. If you want to use a centralized platform but don’t want to go through the KYC (Know Your Customer) process, you might be out of luck.
This feature is important if you need to exchange fiat currency — like U.S. dollars (USD) —to cryptocurrency and vice versa. It offers an easy way to enter and exit the market through the use of debit or credit cards, and bank wires or transfers. Many centralized platforms offer a way to connect your bank account so you can quickly and easily purchase your favorite cryptocurrency. This is a convenient method of eliminating one of the many barriers associated with crypto trading.
While this sounds complex, it's actually pretty straightforward. Assets like BTC and ETH use separate blockchain technology. As a result, the two reside on their own independent blockchains. Trading one for the other can be a headache since most tokens don't implement interoperability standards.
However, centralized platforms overcome this issue by gaining custody of these crypto assets that reside on various chains. This gives the user the liquidity needed to perform a trade quickly and easily. Unfortunately, this is an area in which decentralized finance struggles — for now.
DeFi, or decentralized finance, is the idea that third-party intermediaries — like exchanges and banks — aren't needed to perform financial transactions. The goal is to provide anything you could obtain in real life and make it available without the centralized aspect users often encounter.
With DeFi, every action is completed through self-executing smart contracts, made popular by the Ethereum blockchain — where transactions are automatically executed without the influence or imposition of a third party. DeFi offers a variety of financial instruments, including derivative and cash investments, which are completely decentralized.
On a DeFi system, users have complete control over their assets. You own the private keys for your crypto wallet, which means you are ultimately responsible for the safety and security of your assets. Through the use of DeFi applications, or dApps, users can access a wide variety of services and features available in the DeFi ecosystem.
It's not as easy to find decentralized exchanges and platforms as it is to find their centralized counterparts, but they're out there. Unagii, for example, is an established platform that assists with growing your digital assets with yield farming and staking. Here’s some key features you'll find with decentralized platforms:
Also known as permissionless, this feature lets users access DeFi apps and services without providing personal information. Since decentralized finance is open and accessible to anyone, barriers are removed, making it easier to perform transactions with your favorite DeFi tokens. Plus, with a permissionless system, users develop products designed to benefit everyone, which helps drive collaboration and innovation within the DeFi community.
Additionally, a permissionless and anonymous blockchain provides opportunities to those throughout the world who don't have access to personal identification documentation. There are a significant number of people who lack access to banks, which makes CeFi trading and investing difficult. DeFi aims to remedy this problem through the use of its permissionless applications.
02-Trustless and Transparent
In a truly decentralized blockchain, all transactions are transparent and verified by every user on the network. But what do we mean by trustless? The term itself gives off a negative connotation, but that’s not the case when it comes to blockchain technologies.
In this regard, trustless is saying that all parties involved reach a consensus together. Trust is shared among stakeholders, rather than concentrated in the form of a single entity (e.g., a bank) or individual.
For most DeFi transactions, there is no option to make the information private, which means everyone can see what's going on. Plus, the code is open source, so anyone can view, use, or audit it anytime they want.
On a DeFi platform, you have control over your finances. While you do have to deposit your funds to the smart contract, the platform you’re using does not have access to your funds. You don't have to rely on a financial institution or lender to tell you how to manage your investments or whether you qualify for a loan. Within the DeFi environment, smart contracts take care of all that for you.
This is where the rubber meets the road. How do decentralized finance and crypto work together? How can you use them to your benefit? These are great questions, and they have great answers. Let's explore a few use cases that allow you to make your crypto work for you on a decentralized exchange. However, keep in mind that there are plenty more use cases than the ones mentioned below.
Defi lending protocols exist on a decentralized platform that gives borrowers and lenders a way to communicate. One group provides liquidity to earn interest rates, while the other pays interest on the loan. It's a win-win for both parties.
One lending platform that offers these types of decentralized services is Aave. This DeFi project offers fixed and variable rates, which change constantly based on demand. Fixed rates, of course, remain the same regardless of current market conditions.
Another popular way to put your decentralized crypto to work is by trading and investing in decentralized assets. Since many DeFi assets have a low market cap, it's not uncommon to see their value double or triple in a short time. Of course, there is a significant amount of volatility in the crypto world, so only invest what you're willing to lose.
Decentralized exchanges like Uniswap, Sushiswap, and others offer long-term investing or short-term holding. So, whether you plan on holding your crypto until it hits the moon or you like to make trades a few times a day, there's an option available for you.
If passive income appeals to you more, yield farming might be for you. It's a great way to earn money for doing nothing. Users participate in yield farming by providing liquidity (crypto assets) to a decentralized exchange. The exchange, or DEX, then uses that liquidity to complete token swaps in real time.
Based on the amount they've contributed, yield farmers realize profits from the fees paid by those who trade tokens. The goal is to gain access to the liquidity pool offering the highest possible yield for yield farmers. As a result, yield farming often requires moving from one pool to another to find the best rates.
With decentralized platforms, users can stake their tokens to assist with confirming blocks on a blockchain network and earn rewards while doing so. Staking helps to secure the network and make it more decentralized. While stakers can typically validate on their own, platforms like Unagii are taking on the grunt work for their users by allowing stakers to delegate for convenience and the platform takes care of the rest.
Crypto can be challenging. Your earnings could grow significantly one day only to see it all come crashing down the next due to volatility. The risk of investing in this fledgling market is still high, but the good news is that there are plenty of decentralized applications to help offset these risks.
As a nascent market, the total value of DeFi is still small compared to bigger industries like centralized and traditional finance. But that doesn't mean it's not worth exploring. There is plenty of opportunity for growth and maturity in the years to come, so don't write it off as just another fad in the world of blockchain and cryptocurrency.
Should you invest in DeFi? That's a question you'll have to answer for yourself. But if you decide you want to dip your toes into the pool, check out Unagii. It's a great way to get your feet wet in the world of decentralized finance.