What is DeFi?
Confession time! When I first heard the words “Decentralized Finance”, I was like “but isn’t all of crypto DeFi? Why are people making such a big deal out of it the past year?” I needed to dig deeper.
I’ve since discovered that it kind of is the same thing BUT the DeFi movement refers to a specific genre of financial product that champions decentralization above all else and uses lucrative incentive mechanisms to encourage investors to play along.
DeFi takes the basic premise of Bitcoin – digital money – and expands on it, creating an entire digital alternative to Wall Street, but without all the associated costs (think office towers, trading floors, banker salaries, commission). This has the potential to create more open, free, and fair financial markets that are accessible to anyone with an internet connection.
Among the most popular projects are lending protocols Aave, Maker, and Compound. These are protocols that let you borrow cryptocurrencies instantaneously and often in large amounts if you can prove you can pay back the loan in a single transaction. You can also earn interest from lending out cryptocurrencies.
Then there’s Uniswap, a decentralized exchange that lets you trade any Ethereum-based token you like or earn staking rewards.
Why should you love DeFi?
- Lending: Lend out your crypto and earn interest and rewards every minute and not monthly. This is called staking.
- Getting a loan: Imagine obtaining a loan instantly without filling in paperwork! These include extremely short-term “flash loans” that traditional financial institutions don’t offer.
- Saving for the future: Put some of your crypto into savings account alternatives and earn better interest rates than you’d typically get from a bank.
Everybody loves passive income and staking gives you some of the best returns you will not get from any bank or dividend-paying stock. Crypto staking is the process of locking up crypto holdings in order to obtain rewards or earn interest. Cryptocurrencies are built with blockchain technology, in which crypto transactions are verified, and the resulting data is stored on the blockchain. Staking is another way to describe validating those transactions on a blockchain.
When a crypto investor stakes their holdings, the network can use those holdings to forge new blocks on the blockchain. The more crypto you’re staking, the better the odds are that your holdings will be selected. Information is “written” into the new block, and the investor’s holdings are used to validate it. Since coins already have “baked in” data from the blockchain, they can be used as validators. Then, for allowing those holdings to be used as validators, the network rewards the staker.
You get rewarded for locking up your coins and increasing the efficiency of the blockchain.