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What is DeFi?

two people using a defi dashboard

Cryptocurrencies have gained unprecedented popularity in the last few years. However, with the volatility of the Crypto market making trading more difficult, people have been looking for other ways to invest. Decentralised finance or DeFi has emerged as one such alternative. But what is DeFi, and why should you be considering it?

What is DeFi?

DeFi (decentralised finance) is a blanket term for financial tools, services and products built with blockchain technology. There is usually a decentralised alternative for most financial services, but you might use DeFi for lending, sending and investing in Crypto. It offers a variety of financial services that are secure, independent, and decentralised. With DeFi, you have the power to invest your money in a variety of ways without having to trust a third party. Smart contracts govern all DeFi services, enabling digital transactions between multiple parties.

What is a dApp?

A dApp (decentralised application) is an application that runs on the blockchain. Therefore, it is not controlled by a central authority but by the users themselves. dApps are made possible by blockchain technology, which allows for secure, transparent and decentralised transactions.

How Does DeFi Work?

DeFi is a relatively new way to send, receive, and invest your money without the need for intermediaries. With DeFi, you can instantly send any amount of money anywhere in the world. And it’s all secured by smart contracts on the blockchain. A smart contract is a kind of account that can store funds and send them so long as you meet the conditions of the agreement.

In the world of DeFi, a smart contract replaces your bank. Smart contracts allow you to handle your funds and make transactions for yourself rather than trusting a third party to do it on your behalf. Furthermore, once a smart contract is live, it becomes impossible for anyone else to modify it and will keep running to its coded schedule. Smart contracts are available for anyone to inspect and audit, so unfair contracts can quickly come under DeFi community inspection and scrutiny.

Understanding DeFi – DeFi vs Traditional Finance

So why would someone want to use DeFi instead of traditional finance? The best way to understand the potential of DeFi is to appreciate the main problems that exist with conventional financing:

  • It’s not always possible to get approved for traditional financial services
  • Some people can’t get approval for, or don’t want, a traditional bank account
  • Different time zones and business hours can impact trading hours
  • Funding applications, approvals and transfers can take a long time due to human-controlled processes
  • Financial organisations usually charge more interest as they need to take a cut
  • Financial businesses hold your personal data
  • Centralised institutions can close markets whenever they want

Comparing DeFi to Traditional Finance

DeFi Traditional Finance
You hold your money Other companies hold your money
You decide where to move your money to and how to spend it Companies manage and move your money on your behalf – you must be able to trust that they won’t take risks with it
It takes only a matter of minutes to complete transfers of funds It takes only a matter of minutes to complete transfers of funds
Manual processes and procedures can delay how quickly you can send or receive funds
You conduct transactions under a pseudonym Financial activity links to your real identity
Anyone can use DeFi There is usually an application process which may exclude some people who don’t meet criteria
Markets are available 24/7 Markets only available during business hours
It’s a transparent system – anyone can inspect a products data Financial organisations will not let you examine their trading data, loan history or other operational information

What can you do with DeFi?

There are a growing number of ways you can use DeFi for your financial transactions:

Send Money Quickly

Sending money quickly and easily anywhere in the world is one of the main benefits of using DeFi. All you need is an internet connection and a DeFi account, and you can send money to anyone, regardless of where they are.

Stream Money Anywhere

Streaming money allows you to do things like paying someone their salary by the second, which means that they always have cash available when they need it. It is also possible to stream money by the second to rent something, such as an electric scooter or storage space. In addition, you can stream money anywhere globally, which means that you can use it to pay for things no matter where you are.

Access Stable Currencies

Cryptocurrencies, such as Bitcoin, can be volatile, and their instability can make them challenging to use for anything other than investment purposes. DeFi has solved the problem of Cryptocurrency volatility with stablecoins. These coins maintain a value linked to another asset, usually a popular currency like dollars. Stablecoins are perfect for everyday transactions, and they offer a more stable alternative to other Cryptocurrencies. You’re able to use stablecoins for investment through AQRU and earn up to 7% returns.

Borrow Funds

Borrowing from a decentralised lender has many advantages over traditional institutions:

Borrow with privacy

Third parties lending out large sums of money need to assess whether you will be able to repay them the funds you borrow. Therefore, you must prove your identity and be subject to a financial background check to investigate your financial history and credit score.

However, with decentralised lending, neither party is required to identify themselves. Instead, the borrower must collateralise the loan. The lender will receive this collateral if the borrower fails to repay them. With DeFi, you can borrow money without the need to give out your personal data or undergo credit checks.

Global Funding

Decentralised lenders deposit funds worldwide, so you are not limited to funds managed by just one bank or provider. As a result, there is a greater choice of accessible loans available through DeFi, which usually means that you get better interest rates.

Tax Efficient

Selling your ETH is a taxable event. However, DeFi gives you the option of using your Crypto as collateral for a stablecoin loan. In this instance, you get the funds you need and keep your ETH (so long as you meet the agreements of the smart contract and repay the loan).

Start Crypto Savings

Interest rates from lending out your Crypto on dApps are usually much higher than you can get on a savings account with a bank, so you can quickly see returns. For example, you can benefit from high-interest returns of up to 7% APY by investing in Crypto with AQRU.

Fund Your Ideas

DeFi offers ideal platforms for crowdfunding opportunities:

  • Decentralised markets are always open, so there is more chance for potential providers to get involved
  • It opens up more avenues of funding from global providers
  • Fundraisers can prove how much they have raised and how they have spent funds due to the transparent nature of DeFi
  • The fundraiser can arrange automatic refunds if they cannot deliver on their idea

Buy Insurance

With more automated processes, insurance is more affordable and claims are faster with DeFi. It is also completely transparent, so you can see all the data regarding your claim.

Manage Your Portfolio

When you have a lot of money invested in different places, it can become more and more challenging to keep track of it. DeFi’s open architecture allows you to coordinate, track and manage all of your loans, trades, swaps and investments digitally. Many products have an easy-to-use interface, allowing you to see all your balances and activity in one place.

Are there any risks?

The most common risks associated with using DeFi are human error based, although you should also be aware of market and system risks too.

Human Error

One of the main risks associated with DeFi is human error, such as accidentally sending funds to the wrong address or forgetting to repay a loan.

Smart Contract Risks

Smart contracts govern DeFi tools and instruments. Once these contracts are live on the blockchain, they cannot be amended or stopped. Therefore, if you enter into a new, unaudited agreement, you could be at risk of errors in the contract code.

Fraud Risks

Your funds could be at risk from hostile DeFi tools created by actors wanting to cash in quickly or scams. Therefore, it is essential to vet any DeFi tool you are thinking of using and only use those with a good reputation.

Market Risks

Cryptocurrencies are volatile, and the prices can go up or down very quickly. So if you’re using your Crypto as collateral, you could lose it if the price drops too much.

Liquidity Risks

Liquidity risks may occur in situations where a DeFi tool requires lenders to deposit their funds for a certain amount of time or until a predetermined event happens. Therefore, you could find yourself in a situation where you can’t get your money out when you want it.

Systemic Risks

There are also risks associated with the underlying technology. For example, if the network goes down, you won’t have access to your funds.

By taking the time to learn about DeFi, you can minimise any risks while enjoying all the benefits that this new technology has to offer.

Conclusion

In short, DeFi is a group of tools, products and services that allow you to do everything from borrowing money to buying insurance without the need of a middle man. It’s completely transparent and easy-to-use, making it perfect for managing your portfolio, crowdfunding or earning interest on your Crypto. The emergence of DeFi products is an exciting development in the world of Cryptocurrency, and it’s only going to get bigger and better in the years to come.

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