DeFi Explained: A Beginner's Guide to Decentralized Finance

What is DeFi and how does it work?

Decentralized finance is something crypto insiders have passionately harped on about for years without really explaining the concept.

So, we're going to go ahead and do that for you in this easy guide to decentralized finance.

You've had the question what is decentralized finance? stuck in your head every time you look at Compound (COMP) and Celsius (CEL) mooning day in and day out.

Let's kick this guide off with a one-liner — decentralized finance is peer-to-peer financial services.

Now, as convenient as quick explanations are, they don't tell the whole story.

That's why you should continue reading below to understand why decentralized finance is valuable, revolutionary, and something you can't ignore.

Decentralized Finance Is Open, Global Finance for Everyone

The current financial system is pretty exclusive, meaning; there's plenty of red tape between you and receiving a loan, for instance.

To start, you'll need a bank account, favorable credit history, and a whole slew of personal data including employment checks, loan purpose — the list goes on.

If you go through these requirements one by one and check them against a sample population picked at random from all around the globe, you'll end up with very few who qualify for basic financial services.

Today, there are almost 2 billion unbanked adults worldwide.

That's a quarter of the earth's population without access to a basic bank account.

If there's a metric that can properly illustrate just how broken the centralized financial system is, 2 billion unbanked adults is it.

In contrast, the decentralized financial system is telling everyone to climb aboard, provide services to each other, and find inclusion in the global economy.

The internet has gone a long way in building the framework for a truly global economy, but the financial layer was missing until blockchain engineers went ahead and built it (thanks, Satoshi Nakamoto).

What makes decentralized finance so different?

No credit checks. No employment checks. No personal data required. With nothing more than a smartphone and an internet connection, anyone can use blockchain-based financial services applications to:

• send + receive money instantly at low or no fees
• open high-yield savings accounts
• receive instant cash loans
• trade anything

What's more, the #DeFi movement is just getting started.

Benefits of Decentralized Finance

You're not likely to do something unless it will benefit you, right?

We're the same way. After all, why change if there is no apparent upside?

But when it comes to decentralized finance, there is definitely upside.

Transparency — Traditional financial terms, conditions, and operations happen on a need to know basis, but unless you're on the bank's side, you don't need to know. DeFi parts the curtain using blockchain-based smart contracts, putting both parties in a financial arrangement on equal footing.

Security — There's a lot of value on the table when using financial services. Your personal data — not to mention money — is placed in the hands of centralized organizations that can be hacked, robbed, or deceived by well-placed insiders acting maliciously. These things will progressively become less possible in the world of DeFi because everything operates using highly-secure, human-free smart contracts.

Direct — Why are loans so costly to borrowers, and savings accounts so low-yielding? Overhead and greed are two major components to every intermediary financial institution standing between counter-parties. Decentralized finance cuts out the third-party by organizing a direct, peer-to-peer arrangement between parties that is secured using blockchain-based smart contracts.

Decentralized Finance Use Case #1 — Cryptocurrency Loans

What can decentralized financial services offer you right here, right now?

An instant cash loan approved on the spot without checks of any kind.

If that sounds strange and unexpected (what does a cash loan have to do with cryptocurrency?), that's because it is, and therein lies the genius.

In a nutshell, getting a cash loan with cryptocurrency works like this.

1. Own cryptocurrency (major digital assets like Bitcoin, Ethereum, and Litecoin are best).
2. Go to a decentralized finance platform such as Compound.
3. Create a loan offer as a borrower that details your desired loan terms and cash amount.
4. Wait for a lender or group of lenders to bite.
5. Collateralize the loan with your cryptocurrency from step 1.
6. Voila, loan approved!

There are also semi-decentralized crypto loan platforms like Celsius Network, Nexo, and BlockFi that use blockchains for transparency, don't require checks, but do centralize certain processes.

Using one of these semi-centralized crypto loan platforms, the process of getting a cash loan backed by your cryptocurrency holdings is even faster.

1. Create an account at Nexo, Celsius, BlockFi, or the decentralized finance platform of your choice.
2. Deposit cryptocurrency in your platform-based secure crypto wallet.
3. Apply for a loan at an LTV ratio that suits you (most platforms have a 50% maximum LTV ratio).
4. Instant approval and cash deposited to your bank account or cash card within minutes.

The seamlessness of receiving a crypto loan is a big reason behind not only the success of DeFi platforms but also universal praise toward them.

Decentralized Finance Use Case #2 — Cryptocurrency Savings Accounts

What do the words high yield savings account mean to you?

According to traditional financial guru Nerdwallet, a high-yield savings account means 1% APY max. Wait a second, 1%?

Wipes glasses

Yeah, a measly 1% on the high side.

Decentralized finance platforms blow traditional savings accounts out of the water by offering cryptocurrency savings accounts with APY returns between 5% and 11% depending on:

1. Type of digital asset deposited
2. Amount of digital asset deposited

Generally speaking, DeFi platforms give better APY when you deposit stablecoins.

As a quick aside, a stablecoin is a cryptocurrency that is backed 1:1 with another asset — usually a fiat currency such as USD.

Stablecoin deposits in crypto savings accounts usually net about 10% APY for a truly high-yield experience that actually rewards you for holding your investments in one place.

Bitcoin savings accounts garner slightly less than stablecoins, but at an average of 8% APY to do nothing but park BTC that you're holding anyway, 8% is certainly generous.

For a deeper look at how to earn interest on your crypto along with the best DeFi platforms for doing so, check out this handy guide.

Decentralized Finance Use Case #3 — Become a Lender

What if you don't need to borrow cash and crypto savings accounts aren't hitting the spot with one-size-fits-all savings options?

That's when you go fully custom and earn interest on your cryptocurrency by becoming a lender yourself.

See, in the traditional financial industry, lenders are banks and major institutions. With the gentle rise of micro-lending in the early 2000s, we had a preview of what something approaching p2p lending might look like, but the industry didn't quite take off.

However, it wasn't until the invention of blockchain that truly secure p2p lending was possible.

Smart contracts are lightweight programs that run on blockchains with a set of executable instructions. Once live, smart contracts perform their duty on an if/then basis according to their protocol instructions and new data that comes in.

Using a DeFi platform like Compound to offer a crypto loan on your own terms then becomes a matter of letting the smart contract handle the technical aspects of the loan.

When and if a borrower doesn't make a payment on time, or when their collateral loses value due to market volatility, the smart contract jumps into action. It can alert the borrower to deposit more collateral, initiate a margin call to secure your funds, or deliver a late payment penalty.

These are, of course, all things that people in offices with centralized systems used to do, but with the advent of Ethereum smart contracts, people can securely provide financial services to each other with intermediaries.

Decentralized Finance Use Case #? — Tokenize and Trade Everything

The most profound impact of the DeFi movement is the eventuality that through blockchain-based platforms and applications, anything that can be represented will be tokenized and traded.

We're talking about global liquidity on a scale that today seems impossible, but with a few years time, will be inevitable.

That's where today's cryptocurrency exchanges are leading — currently, they enable trading for thousands of cryptocurrency assets that are native to blockchain systems.

What happens when blockchain is standardized across not just frontier tech, but each and every sector including segments as disparate as real estate and organic agriculture?

At that point, we'll see heirloom black rice grain futures exchanged alongside collectively-owned S&P 500 digital assets — all happening without third parties taking a cut or presenting security risks.

The possibilities for the #DeFi industry are endless, making it vital to stay dialed in to this quickly developing and essential blockchain contribution.

Now that you finally found the answer to ‘What is DeFi?’ you can finally start your journey and discover just how beneficial features like yield farming and flash loans are!

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