ALL YOU NEED TO KNOW ABOUT DEFI BASICS

DeFi as the name suggests, is like the traditional bank to save, invest, or borrow money but modernized. A modernized bank where you have full control over your money, without needing permission from any institution. This Decentralized Finance (DeFi) is a new financial system that removes middlemen and puts the power back into the hands of everyday people.
If you’re hearing about DeFi for the first time, don’t worry. This article is written just for you! I will break it down in simple terms, explaining how it works in this era and the future to come.

What is DeFi?
Decentralized Finance (DeFi) refers to a financial system built on blockchain technology that eliminates the need for traditional banks and financial institutions. Instead of relying on banks to handle transactions, DeFi uses smart contracts (self-executing contracts with the terms of the agreement directly written into code) to enable peer-to-peer financial activities.
In simpler terms, DeFi is like an open and digital version of the traditional banking system but without banks. It allows anyone with an internet connection to access financial services such as lending, borrowing, trading, and earning interest without needing approval from a bank.

How DeFi Works
Traditional banks act as middlemen. When you deposit money in a bank, the bank holds it, lends it out, and pays you a small interest in return. In DeFi, smart contracts take over this role. A smart contract is like a digital agreement that automatically executes transactions when certain conditions are met without needing human intervention.
DeFi applications (often called dApps, meaning decentralized applications) run on blockchain networks like Ethereum (a popular blockchain platform that supports DeFi applications). These dApps allow users to interact with financial services without needing a central authority.

Characteristics of DeFi

Permissionless: Anyone can access DeFi services without needing approval from banks or regulators.

Transparency: Transactions are recorded on the blockchain and can be verified by anyone, reducing fraud and corruption.

Self-Custody : Users have full control over their funds through digital wallets instead of relying on banks to store money.

Interoperability: DeFi applications can interact with each other, creating a seamless financial ecosystem where users can move assets easily.

Defi Services Explained

Now that we know what DeFi is, let’s look at some of the services and how they work.
1. Lending and Borrowing
In the traditional financial system, you need a bank or a lender to borrow money. DeFi removes the bank and allows users to borrow and lend money directly through smart contracts.
Lenders deposit their money into a smart contract and earn interest.
Borrowers take out loans by providing collateral (security deposit) in the form of cryptocurrency.
For example, if you want to borrow $500 in DeFi, you might need to provide $1,000 worth of cryptocurrency as collateral. This ensures that lenders are protected in case of loan default.
DeFi lending platforms use an over collateralization model, meaning borrowers must deposit more than they borrow to prevent defaults. Unlike traditional banks that assess credit scores, DeFi loans are purely asset backed.
Popular platforms: Aave, Compound, MakerDAO

2. Decentralized Exchanges (DEXs)
A Decentralized Exchange (DEX) allows users to trade cryptocurrencies directly with each other without needing a centralized authority like Binance or Coinbase.
In a traditional exchange, the company controls your funds and acts as an intermediary. But in a DEX, smart contracts handle the transactions, and you remain in control of your assets.
DEXs use liquidity pools, where users deposit their cryptocurrencies to facilitate trading. In return, they earn fees from traders using the exchange.
Popular platforms: Uniswap, SushiSwap, PancakeSwap

3. Yield Farming and Staking
Yield farming and staking are ways to earn rewards with your cryptocurrency.
Yield Farming: Users provide liquidity (funds) to DeFi platforms in exchange for interest or rewards. This is similar to earning dividends in traditional finance.
Staking: Users lock their cryptocurrency in a network to support its security and operations. In return, they earn rewards, often in the form of additional tokens.
Yield farming can be risky because high returns often come with high volatility. However, it provides a lucrative opportunity for those willing to engage actively.
Popular platforms: Yearn Finance, Curve Finance

4. Stablecoins
One major problem with cryptocurrencies is their price volatility. Stablecoins are cryptocurrencies designed to maintain a stable value, often pegged to traditional currencies like the US dollar.
USDT (Tether), USDC (USD Coin), and DAI are popular stablecoins that keep their value close to $1.
Stablecoins are widely used in DeFi for trading, saving, and making transactions without worrying about price fluctuations. They act as a bridge between traditional finance and the crypto world, offering stability in a volatile market.

5. DeFi Insurance
Just like traditional insurance protects you against losses, DeFi insurance protects users against risks like smart contract failures and hacks.
For example, if a smart contract on a DeFi platform gets hacked and you lose your funds, DeFi insurance can help you recover your losses. This is important because unlike banks, DeFi does not have government backed insurance like FDIC protection.
Popular platforms: Nexus Mutual, Cover Protocol

Perks of DeFi
1. No Middlemen
You don’t need a bank, broker, or financial institution to access services. Everything happens through smart contracts, making transactions faster and more efficient.

2. Global Access
Anyone with an internet connection can use DeFi services, regardless of location. This is particularly beneficial for people in countries with unstable financial systems.

3. Higher Interest Rates
Banks offer low interest rates on savings. DeFi platforms often provide much higher returns due to competition and lack of intermediaries.

4. Transparency and Security
Transactions are recorded on the blockchain, making them transparent and harder to manipulate.

Risks of DeFi
While DeFi has many advantages, it also comes with risks:
1. Smart Contract Risks
If a smart contract has a bug or gets hacked, users can lose their funds. Always use platforms with audited and well reviewed smart contracts.
2. Price Volatility
Cryptocurrencies are highly volatile, and sudden price drops can lead to significant losses.

3. Regulatory Uncertainty
Governments are still figuring out how to regulate DeFi, which can lead to legal uncertainties. Future regulations could impact DeFi platforms and their operations.

Just like any new phase, Web3 and DeFi might seem intimidating at first but that doesn’t change the fact that they’re the future. The shift is already happening, and those who take the time to learn now will be ahead when it fully takes off. So if you’re out there, take this as your sign. The future isn’t some distant concept it’s already here. Don’t wait until everyone else is ahead. Start now!!