Decentralized Finance (defi): 101 Guide

For years, we have been relying on a centralized financial system. Here all transactions are maintained in a private ledger. There is a bank, financial institution, or intermediary that facilitates financial transactions between parties. However, a Decentralized Finance System is gaining popularity nowadays. It is a newly-developed finance infrastructure that is empowering buyers, sellers, lenders, and borrowers. In the case of Decentralized Finances or defi, everything is encrypted in computer code. Here, transactions are automated and intermediaries are eliminated. For that, it uses blockchain technologies, open-source technologies, and proprietary software. Let us understand more about decentralized finance in detail.

Centralized v/s Decentralized 

Consider a scenario where you want to invest in crypto-currency. Here you can use your regular money, i.e., fiat currency to purchase cryptocurrency. For that, you’ll have to create an account with a crypto exchange. You can use a platform that uses decentralized finance to ensure that the Blockchain system used does not go through a centralized intermediary. Instead, it facilitates direct communication between the two participants. 

Simple as it may sound, it is pretty complex. In a centralized financing system, you have intermediaries handling the finances, and there are regulatory authorities who can even keep a check on the currency’s value. However, decentralized finance is entirely based on the communication between the two parties and the transaction occurring between them. The Blockchain creator will have to ensure that the currency’s value remains close to a standardized currency.  In this case, its value is kept close to US Dollars to ensure the authenticity of the transaction.

Features of Decentralized Finance

In a centralized financing system, the monetary transaction that you make is stored in a private ledger that you can access. But in a decentralized financing system, it is stored in a public ledger. However, the entire transaction is encrypted and recorded in a computer code. It might sound that in a defi crypto, the chances of hacking increase; however, the result is the exact opposite. 

In a Blockchain, all transactions are recorded and encrypted through complex computational codes.  Also, copies of the transactional application are maintained in encrypted code. Unlike a centralized financing system, there are no gatekeepers or middlemen. The entire system is managed by encrypted codes making the system virtually impossible to hack. The security of the system is such that it provides the user with complete anonymity. The verification of the transaction and the authenticity of the asset are done entirely by the system. This makes it almost impossible to make a fraudulent transaction. 

When you make a transaction through a decentralized financing system, you can be assured that the transaction will be authentic, and you and be assured of the entire process. You will also be assured that the currency used will also not lose its value because this is necessary to maintain the authenticity of the transactions.

Importance of crypto-currencies in decentralized finance

When you think of decentralized finance, you will have to consider carrying out all the transactions using crypto-currencies. There are several such currencies that you can use when you use DeFi. For example, if you use the Ethereum Blockchain, you can consider using the DAI or a stable coin crypto-currency. If you observe the volatility of crypto-currencies, you might feel deterred about investing in them. However, the Ethereum Blockchain has reinvented the entire DeFi market by introducing a stable coin. The stable coin ensures that the value of crypto-currency remains steady and does not fall significantly compared to the US Dollars. Usually, the value of one DAI will remain close to one US dollar. This makes the transactions easier.

Additionally, you will also feel comfortable using the platform to make the transactions. When you use the platform as a DeFi exchange center, you can connect with other persons directly. With the help of a stable currency, this becomes easier, making the transaction hassle-free. 

Ways to trade in DeFi 

Some of the options to trade/invest in the DeFi are as follows:

  • Decentralized exchanges: These remain one of the most volatile currencies used for peer-to-peer financial trading. You can use crypto-currencies for both centralized and decentralized trading. But you can use the same currencies on the platform to secure the trading through DeFi.
  • Yield harvesting: This is considered to be one of the highest-yielding crypto-currency investments. In this case, loans are given against crypt-currency speculations, and it often reaps good rewards. This, too, occurs through DeFi exchanges and can yield excellent returns.
  • Non-fungible tokens or NFTs: These are commodities that are traded on the DeFi platform against crypto-currencies. You can purchase products using crypto-currency and create digital assets and non-tradable assets. With the help of NFTs, you can now make a digital asset out of a commodity that you could not convert into a commodity previously. The DeFi platform ensures complete security of the NFTs, and it remains encrypted.
  • Crypto-currency loan: The Ethereum Blockchain ecosystem, with the help of its unique stable coin currency, has successfully distributed loans in the form of crypto-currency. Anyone requiring a loan can raise the requirement right through the platform, and the loan is disbursed through the platform itself. The entire system’s security ensures that you do not require any lawyer or underwriter for the loan. Once the loan is disbursed, the crypto-currency moves to your digital wallet, and the entire transaction occurs through a secure transaction. You can then invest in the crypto-currency and return the investment when the loan is recovered in a similar route. This transaction, too, remains secure.

Crypto-currency transaction on the DeFi platform is secure and can be considered a locked value. Several protocols need to be followed to ensure that a transaction is completed. The Blockchain may be globally available, but the security is virtually unbreakable.

Utmost Security with Private key requirements

Although there are security measures, the DeFi platform has several protocols that need to be followed to complete a transaction. It is necessary to ensure that there is no breach at any section. The primary issue that lies with DeFi is that the Blockchain is available in the public domain. Hence, it would help if you had the private key to your digital wallets. There should be no unauthorized activities in your digital wallet. If you have a digital wallet connected to your crypto-currency ledger, you should have a private key.

Additionally, it would help if you did not discuss your transactions on a DeFi platform on an online forum or discuss it. However, it will make your private key vulnerable and draw the attention of hackers. The private key is an authorization code that is known only to the owner of the wallet. It would help if you remembered it because there is no way that you can recover a lost private key. If you lose the key code, then your crypto-currency in the digital wallet will also be lost. So it is essential to have a private key for your security, but it is also equally important to remember it. 

Closing note

The DeFi platform is revolutionizing the entire way in which that crypto-currency is perceived. It offers security to transactions and makes it easier for individuals to connect over the platform. For example, the buyer and seller of the crypto-currency can connect over the platform directly. Similarly, anyone looking to take a loan or looking to invest in crypto can do it on the platform directly. In addition, the DeFi platform offers stability by giving secure currencies that try to maintain a value similar to standard fiat currencies. Therefore, if you want to invest in crypto-currencies, you can look to the DeFi platform for greater returns on your investment.