What is DeFi? The Ultimate Guide to Decentralized Finance

What is DeFi Decentralized Finance Ultimate Guide
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Learn everything you need about decentralized finance with this ultimate guide by DappRadar

Blockchain technology has opened the door to a new world of opportunity for decentralized finance and personal banking. Now, instead of letting banks make the rules, users control their finances and can reap the rewards for doing so. 

With all this new technology innovating and changing so quickly, it’s only natural that people have questions. Fortunately, DappRadar has you covered. 


What is Decentralized Finance? 

DeFi, or decentralized finance, is an overarching phrase for financial services operating on public blockchains. In DeFi, you can do almost everything traditional banks support but faster.

This includes earning interest, borrowing, lending, buying insurance, trading derivatives, trading assets, and more. It doesn’t require paperwork or a third party on the blockchain. Moreover, DeFi is global, peer-to-peer, pseudonymous, and open to anyone.

Why are people using DeFi? 

DeFi and decentralized exchanges (DEXs) around the world allow anyone easier access to credit, lending, and borrowing activities. This technology changes the landscape of the conventional financial systems.

Users make trades and move their assets wherever they want without waiting for bank transfers or paying standard bank fees. Although other crypto-specific fees, such as gas fees, may apply.

The major benefit of a DEX is that these exchanges don’t require users to deposit their money onto the exchange. Instead, users connect their blockchain wallets and trade directly from there. In addition, price manipulation and false trading volume aren’t possible, as the money comes from users themselves.

However, it’s an illusion that all activity on the blockchain is anonymous, for example, some decentralized exchanges block users based on IP address. Some of these DEXs also have know-your-customer (KYC) requirements in place.

Getting to know the best DeFi dapps

There are many DeFi projects out there bringing solutions across different blockchains. The best way to learn about them and to keep up with the market is to see the DappRadar Top DeFi Dapps Ranking.

Getting to know the best DeFi dapps

DeFi dapps on various blockchains, not only Ethereum, offer its users a new level of decentralization and financial freedom. Uniswap is the most successful decentralized exchange, with billions of dollars in total value locked across its smart contracts. Uniswap is an Ethereum-based protocol that uses smart contracts to hold crypto assets in liquidity pools.

However, Ethereum gas fees are costly, so some of these dapps are shifting toward layer 1 and 2 scaling solutions. For example, Solana, Polygon, BNB Chain, Avalanche, and Fantom can lower the trading costs for investors.

Furthermore, as you may realize, it’s deeply connected to the cryptocurrency market.

DappRadar DeFi Overview

The landscape is changing fast, so it’s best to stay up to date using the DeFi Overview tool to follow how the industry moves.

Best DeFi tokens

The tokens attached to the leading DeFi dapps are destined for more growth and longevity than those attached to failing protocols.

With DappRadar, users can discover the leading DeFi dapps and their native tokens on all the significant blockchains. This includes Ethereum, Solana, Polygon, and BNB Chain – DappRadar tracks dapps on over 50 blockchains.

Top DeFi Crypto Tokens

Where do decentralized exchanges get their money reserves?

Decentralized exchanges cannot call on centralized money reserves and rely exclusively on their users. Users can place cryptocurrencies into liquidity pools on decentralized exchanges and receive rewards for providing liquidity.

For example, the pool of tokens containing ETH and USDC. This pool is big enough to allow swapping ETH for USDC without significant price impact.

What are liquidity pools? 

Liquidity is the ease with which you can change your crypto to fiat currency or another asset without affecting its price.

A liquidity pool is a crowd-sourced pool of cryptocurrencies or tokens locked into a smart contract within a particular dapp that is used to facilitate trades between the assets on a decentralized exchange (DEX). Moreover, a DEX is useless without liquidity as it cannot facilitate transactions at reasonable rates. 

Understanding liquidity providers 

Liquidity providers are investors who place cryptocurrency tokens on DEXs to earn transaction fees, often called liquidity mining or market-making.

The rewards vary based on the amount of liquidity available and the number of transactions in the liquidity pool. Liquidity providers are essentially the backbone of the DeFi space, as, without their input, a DEX could not perform its essential functions. 

Making sense of DeFi wallets

A DeFi wallet is a non-custodial wallet that stores a user’s cryptocurrency and digital assets. They are non-custodial, meaning only those with the unique seed phrase or private key can access the funds. Non-custodial wallets differ from those issued by centralized exchanges like Coinbase or Crypto.com, for example. 

Those platforms simplify onboarding by creating a wallet for every user but never asking them to store private keys or seed phrases. In return, users of centralized exchanges sacrifice control over their assets, just like with a traditional bank.

However, a major difference between a bank and a crypto exchange is that deposits to a bank are often regulated and insured by government deposit schemes. The two types of non-custodial wallets utilized most:

  • Hardware wallets: while they look like USB sticks, they allow users to store their funds offline, often called cold storage. Examples include Ledger and Trezor.
  • Software wallets: online wallets you access through your web browser or phone. Popular examples include Metamask, Trust Wallet, and WalletConnect.

Know your stablecoins

A stablecoin refers to a cryptocurrency pegged to another asset’s price, such as the US dollar, pound, or euro. The price of a stablecoin cryptocurrency does not fluctuate.

Instead, it follows the peg of its brother currency. Of course, if the peg fails, so does the stablecoin—an issue not truly faced by the industry as yet. The two most commonly used are USDT and USDC, pegged to the US dollar.

Stablecoins are popular with traders who need to move in and out of trading positions while hedging against a particular crypto.

Why are there so many decentralized exchanges?

The variety of decentralized exchanges contributes to the advancement of the entire area of decentralized finance. Also, different teams looking for solutions to similar problems make Web3 such a fast-paced area of technology.

Top 10 Decentralized Exchanges

Also, Decentralized exchanges such as Uniswap exist in an open-source way, meaning anybody with the necessary development knowledge can come along and essentially fork or copy and paste Uniswap’s code into another dapp, giving it a new name with almost identical functionality. 

When a dapp is forked, it complements the original protocol’s design and functionality but can essentially bring about competition in a small space. Uniswap has been forked thousands of times, and so has OlympusDAO.

Why do you pay a fee to swap tokens on a DEX?

Simply put, a decentralized exchange (DEX) makes its revenue from fees, just like any exchange. The core difference is that the fee is written into the smart contract on a DEX and executes automatically without needing third parties. For example, the contract will simply send 0.1% of the traded amount to the exchange’s wallet. Fees are also collected and distributed to liquidity providers to incentivize them to add liquidity in the first place. 

How to make money in DeFi?

The value locked up in Ethereum and alternative blockchain DeFi dapps has been rising steadily since the summer of DeFi in 2020, with many users reportedly making a lot of money. Using blockchain-based dapps, users can generate passive income by loaning out their money and generating interest from loans. Additionally, yield farming can bring even more significant returns with considerable risks. It allows users to leverage the lending aspect of DeFi and put crypto-assets to work, generating returns. 

What is DeFi staking? 

Staking in DeFi is locking up tokens in a smart contract to provide liquidity. In return, users gain rewards in that token, or another, over the timeframe they allow it to be locked up.

In many ways, it’s similar to depositing money in a bank fixed deposit, like a savings account. Except in crypto, the percentage rewards for doing so are far greater than in traditional banks, which generally mirror global interest rates. 

For example, RADAR token holders can stake their RADAR directly on DappRadar to earn more RADAR. Furthermore, in an industry-first move, DappRadar has pioneered cross-chain staking so that RADAR holders can stake and harvest RADAR rewards on any chain, and users can avoid Ethereum gas fees.

What is yield farming? 

Yield farming uses decentralized finance to maximize returns through lending or borrowing crypto on a DeFi platform to earn cryptocurrency. Yield farmers who want to increase their yield can employ more complex tactics and build positions on several networks and applications. Notably, users should always access the costs of these activities compared to the rewards to see if a profit margin exists and over what timeframe.

Lending and borrowing money in DeFi

Crypto lending refers to decentralized finance that allows investors to lend their cryptocurrencies to different borrowers to get interest payments in return. Rewards can float between 1% and 20% on various platforms and higher for certain coins. Many platforms specializing in lending crypto also accept stablecoins pegged to the US dollar.

Moreover, using a DeFi platform, a borrower can take a loan. The lending process is executed from start to finish without intermediaries. Using a smart contract, a token holder sends tokens they intend to lend into a pool. Once the coins are sent to a smart contract, they become available to other users to borrow. A borrower will often have to provide collateral to secure the loan. Afterward, the smart contract issues tokens, usually the platform’s native token, that are distributed to the lender as a reward. 

Staying safe in DeFi

The world of DeFi is brimming with opportunities, but it’s also essential to prioritize your safety. Protecting your identity and investments on the blockchain is fundamental to thriving in this evolving landscape. Here are some critical measures to implement to safeguard yourself:

  • Secure Your Wallet: Using wallets like MetaMask is convenient, but remember, they rely on password phrases for security. Keep your crypto wallet password and seed phrase secure. Don’t store them on public computers; always have a paper backup in a safe location. Never grant remote access to your computer to anyone unknown.
  • Beware of Scams: The crypto space, being relatively new, is unfortunately rife with scam projects. Always conduct thorough research before investing in any dapp or new project. Examine their contract addresses and delve into their social media accounts.
  • Research the Team: Investigate the team behind the project. A lack of information about the development and management teams could be a significant red flag. Most successful crypto projects are transparent about their creators and developers.
  • Never Share Sensitive Information: Never share your private keys, seed phrases, or any other sensitive information with anyone. This information is the key to your funds, and sharing it can lead to irreversible loss.

Staying safe in the DeFi space involves a combination of vigilance, research, and careful management of your information. While the crypto world is full of opportunities, it is crucial to approach them with a healthy dose of caution and skepticism.

Keep up with the DeFi space

DappRadar is the World’s Dapp Store and the leading authority on blockchain analytics. We record and analyze data from thousands of platforms; DeFi is a big part of our work. Rankings pages for DeFi show which dapps are performing the best over different periods. And our dedicated DeFi page gives an overview of the sector to show how it performs.

The DeFi section of our blog offers insights into the latest trends affecting decentralized finance. And we also have articles with updates on the latest news stories related to web3 DeFi apps. Our industry-leading quarterly and monthly reports are used by industry experts and regularly referenced by major media outlets.

Discover DeFi Dapps at DappRadar

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