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What is DeFi or Decentralized Finance?

Posted by
Robert Hoogendoorn

An explanation about the future of finance

What is DeFi? Since the summer of 2020, the blockchain industry has seen tremendous growth, driven by two trends: NFTs and DeFi. DeFi is an abbreviation for decentralized finance. The idea behind decentralized finance is that the middleman gets removed, and users themselves provide the liquidity to allow other users to trade their tokens. 

It’s important to understand that DeFi is more than just token swapping. It’s the ability to earn interest on your holdings through staking, providing liquidity to liquidity pools, yield farm tokens, borrow and lend money, and so on. DeFi embraces most services a bank would normally provide, but the major difference is that there is no bank. No bank, no middleman. All economic transactions happen between individuals, and a protocol or smart contract on the blockchain is what connects these people. 

We can consider decentralized finance an upgrade for traditional (centralized) finance. However, to access the world of DeFi users still need to go through centralized access points, such as exchanges. One might argue that everybody only needs to use this on-ramp once, and when everybody’s converted, our financial system will be decentralized. But that’s not how it works, because we will still need to pay our taxes and electricity bills. When it comes to adoption, we aren’t there yet. 

However, every day more people dip their toes into DeFi. This open financial ecosystem is finding an audience on various blockchains. It started on Ethereum, got even bigger thanks to Binance Smart Chain, and is now also finding its way onto Polygon and other blockchain networks. 

What is a decentralized exchange?

A decentralized exchange allows users to swap their tokens for other tokens, without the need for a central authority. These exchanges use smart contracts to determine the exchange rate and the gas fees required for any transaction. 

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 isn’t possible, as the money comes from users themselves. 

A decentralized exchange doesn’t mean that users swap their tokens anonymously. Some of these DEXs have know-your-customer (KYC) requirements in place. In addition, it’s an illusion that all activity on the blockchain is anonymous, for example, some decentralized exchanges block users based on IP address. The most famous decentralized exchange would be Uniswap.

What’s interesting about DeFi?

The current banking system isn’t the same as it was three decades ago. In the 90s we got 5% interest on our savings, but those times are over. In Europe and North America interest rates or often 0.01% or sometimes even negative. A negative interest rate means that people need to pay to keep their money in a bank. 

In DeFi, even though it’s not without risk, users are able to obtain much higher interest rates on their crypto savings. Simply staking ETH can already provide 4% annual percent yield (APY), or interest. These percentages are often much higher for smaller currencies, new projects and so on. Sure, one needs to educate themselves about each project, and do risk assessments. However, it’s a fact that DeFi can provide much higher APY than traditional financial institutions.

How to get started with DeFi?

Before you start trading on decentralized protocols, it’s important to obtain some of the main currency. For example, on Binance Smart Chain you can use PancakeSwap or ApeSwap and you will need the BNB token to get started. Furthermore on Ethereum you could use SushiSwap or Uniswap and you’d need ETH, while MATIC is the token you’ll need for QuickSwap on the Polygon blockchain. 

As a first introduction into token swapping and dipping your toes into DeFi, we would suggest you to use one of the following dapps. You could also read this article in which we suggest a whole lot more options that allow staking, which means you’d be generating passive income. Staking is best compared with generating interest. 

Most used DeFi platforms

  • Uniswap – Full decentralized protocol on the Ethereum blockchain
  • SushiSwap – Decentralized protocol on Ethereum with SUSHI tokenomics
  • PancakeSwap – Automated Market Maker and Yield Farm on Binance Smart Chain
  • ApeSwap – AMM, Yield Farming and Token Swap on Binance Smart Chain
  • QuickSwap – Decentralized Exchange on Polygon blockchain

Discover many more DeFi protocols or Exchange by checking out the DappRadar Rankings

Keep in mind that this article doesn’t serve as investment advice. Putting money into crypto doesn’t come without risk and you could lose it all. Only invest money you’re able to lose. 

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