In Decentralised Finance, You are Your Bank and Your Banker
In Decentralised Finance, You Control Everything.
As interesting as that can sound, in other to Understand Decentralised Finance, it is important to take a peep into what its counterpart, Traditional Financ, means.
Traditional Finance used to be the primary way in which Finance operated. This simply means the banks and the usual way you pretty much know finance as.
While it still plays a significant role in finance today, its Centralised structures and Operations are what Decentralisation provides solutions to.
The Centralised Operations of Traditional Finance simply explains the control and regulations behind the flow of Money and ownership of Funds. This Centralisation is made possible by Governmental rules that regulate the distribution and control of Money.
So if Traditional Finance provides a Centralised structure and Operation that allows the Government to make regulations that control your money and also allows banks the power to hold your money, which provides them with the liquidity to operate properly via saving and lending.
Then Decentralised Finance provides a Decentralised Structure built on the Blockchain, allowing YOU to make regulations that control your money; giving you the power to own your Money, Save, Lend and invest your money (stake your money).
In Decentralised Finance, YOU are your own bank and YOUR own Banker.
You control everything. And this means that you are also saddled with the responsibility of Securing your Money.
Defi, a simple way of saying Decentralised Finance, offers an Open, transparent and Secure Financial System. And these systems are made possible by the development of different solutions on the Blockchain.
Unlike Traditional Finance which operates on a Centralised system that incorporates the functions of banks during transactions. The bank facilitates every transaction, thereby acting as a third party.
Defi operates a trustless system that eliminates the need for a third party.
Although you use Defi Products like a Decentralised Wallet — typically your bank accounts — where you hold your Crypto Assets, unlike your bank accounts, you truly own your wallet and only you have access to it.
In the World of Defi, you have complete responsibility for everything you want to do, and this could include Investments, exchanges, insurance, etc.
If that’s the case, you would want to know how Defi Works.
How Does Decentralised Finance Work?
The Concept of Decentralised Wallets really creates a baseline on how you can store your portfolio safely. Just as I mentioned earlier, you truly own your wallet and only you have access to it.
The Safety passcodes to your Defi Wallets, Your Keys or Seed Phrases or Mnemonic Codes, are generated by the blockchain, not a third party. You gain ownership of these codes upon the creation of your wallet.
Not your Keys, Not Your Coins — Andreas Antonopoulos.
And not even the decentralised Wallet provider can help you recover these access keys if you get to misplace them. That’s because they do not have access or knowledge of what these keys are.
Owning a Decentralised Wallet would be a safe start to how you start Defi. But they do not make Defi work, rather Decentralised Protocols are what make the concept of Decentralised Finance work.
So what are Decentralised Protocols? They are specialist autonomous programs meant to handle challenges in traditional finance. Some of the leading Defi Protocols include:
Decentralised Lending Protocols and Yield Farming
The concept behind this protocol is simple, you can loan out tokens/Coins or borrow them via non-custodial solutions or platforms.
Aave, Marker, Compound, and Venus amongst others are some of the biggest lending protocols with billions of dollars within their Smart Contract.
Many of these major Lending protocols are on the Ethereum blockchain, which means you can borrow or lend any Erc-20 token and do that knowing these protocol creators do not have leverage on your assets.
Just like traditional Finance, interest rates also apply to lending and borrowing via any of these protocols. So it is important to be knowledgeable about the interest rates before you decide to borrow or lend.
The utilisation of this protocol popularised the concept of Staking. This is when you add liquidity to a Liquidity pool. And in return earn the Governing tokens of these protocols.
These Governing tokens have value, and people who lend money to the Liquidity pool of these Protocols could earn tokens of value. It is similar to when you save money in a Bank — giving them enough liquidity to then lend to people — and then they give you a certain interest as a reward for saving.
It is important to understand that, liquidity is the soul of Defi. Just as Savings is the soul of Traditional Banks.
Both Defi or Traditional banks will not function if there is no money in circulation.
Decentralisation Exchanges and Liquidity Providers
Decentralised Exchanges (DEXs) are another type of Defi protocol. They are automated Market makers that allow traders to buy and sell crypto amongst themselves, more than that, these exchanges have liquidity pools that enable traders to get liquidity to make trades.
Without benign too technical, Liquidity means there’s money available to move around the market and a liquidity pool would mean a large pool or vault of money. Illiquid would mean there’s no money.
Uniswap, Pancake Swap, and Sushi Swap, amongst others, are one of the biggest DEXs available. Just like every other Decentralised protocol, DEXs are also non-custodial protocols and they accept any Erc20 token to trade.
Although the downside to allowing any Erc 20 token on DEXs is the problem of scams. Some tokens were created simply to exploit investors.
Apparently, that would be a problem Centralised exchanges (CEXs) look to solve. CEXs are like DEXs, but they are custodial, amongst other differences like security.
DEXs offer incentive structures to those who bankroll these liquidity pools (people who add money to the liquidity pools of these protocols).
This is popularly known as Yield Farming, where the protocol rewards People who add liquidity to the Pools, they earn fees amongst other perks when someone makes a trade.
Decentralised Stablecoins
Stablecoins are cryptocurrencies whose value is pegged to the US dollar or to another currency, product, or financial instrument.
An example of this would be Tether, a US-Dollar pegged Stablecoin, which currently has about 66 Billion worth of Tether in circulation (as of the time of writing this).
While Decentralised Stablecoins are coins that algorithmic and are not pegged to any central currency, products or financial instruments.
DAI would be a great example of a Decentralised Stablecoin.
Why are stablecoins important? Instead of purchasing Ethereum directly with US dollars, traders frequently exchange fiat for a stablecoin and then trade with the stablecoin. This helps to facilitate deals on DEXs.
That would entail that traders would purchase a stablecoin, like DAI, and use DAI to purchase ETH.
The primary goal of Stablecoins is to maintain a fixed value over time.
Decentralised Finance truly revolutionises Traditional Finance by offering a (YOU) focused Solution. Taking control and regulation away from the government and Putting it back into your hands.
Although this puts an enormous amount of responsibility on individuals looking to leverage Defi, still, it offers a huge avenue to Earn when you utilise both Staking and Yield farming.
Key Takeaways
- In Decentralised Finance, YOU are your own bank and YOUR own Banker
- Defi operates a trustless system that eliminates the need for a third party
- Defi offers an Open, transparent and Secure Financial System
- Decentralised Protocols are what make the concept of Decentralised Finance work. They are specialist autonomous programs meant to handle challenges in traditional finance.
Do you know understand what Defi is and how it’s revolutionising the Finance Industry? Well, I write other interesting Articles like this, and you can check me out on my socials here!
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