DeFi Explained: A Beginner's Guide to Decentralized Finance

DeFi, or more specifically, decentralized finance, is currently one of the fastest-growing sectors in cryptocurrency and blockchain. Unlike traditional financial institutions and intermediaries, DeFi offers innovative blockchain-based platforms and protocols that provide transparency, openness, and automation of financial transactions.

If you are new to the world of DeFi and want to understand its essence and capabilities, this article will give you all the knowledge and key concepts you need to begin your journey into the decentralized financial ecosystem.

How DeFi Works

DeFi's innovative financial system is often drawn closely to cryptocurrencies, but it's worth noting that the goals this system pursues go beyond digital assets and values. The smart contracts inherent in decentralized finance aim to come to replace our traditional financial systems. 

In the world of decentralized Fi, there are no banking companies, institutions, or government organizations that aim to manage finances, since DeFi works without intermediaries, there is no need to authorize transactions in DeFi applications. 

For a sense of transparency in DeFi's protocols, it is open source for everyone. In addition, there are also open networks that bypass national borders and so users have a large number of applications available, a large portion of which are based on the Ethereum network and blockchain. 

DeFi, taking advantage of P2P (peer-to-peer) networks, easily eliminates intermediaries and opens up access to decentralized banking services, although previously this was not possible due to the need to validate transactions through third parties. Because of this, the level of decentralization was questionable and commissions left much to be desired.

The financial crisis of 2008-2009 clearly demonstrated that intermediaries were not fully trustworthy. And customers were often unaware of the important rules and regulations that govern financial products.  

The goal of decentralized finance is to create an open financial market that does not need permission and trust. Much of the technology from the crypto DeFi sphere, has a focus on improving the current financial system, adhering to the potential to improve the user experience for businesses and customers alike.

What goes into decentralized finance

At the heart of DeFi is blockchain technology, and a variety of financial products and services are based on it and can be found on decentralized platforms and protocols. Let's take a look at some of them.

1. Decentralized Exchanges, DEX. On these platforms, you can trade, and exchange cryptocurrencies and tokens directly, without resorting to intermediaries. Examples of these exchanges include Uniswap, SushiSwap, and PancakeSwap.

2. Liquidity Farming. A mechanism that opens the possibility for users to provide their cryptocurrency assets and put them into liquid pools on decentralized exchanges. As a reward, receive a percentage rate or tokens. This is how exchanges provide liquidity for trading pairs. Examples of such platforms include Uniswap, Curve, and Balancer.

3. Staking. You have the ability to stack your virtual tokens and hold them, thereby securing the network. You will be rewarded for this in the form of tokens or a percentage rate. Examples of such networks include Ethereum 2.0, Tezos, and Cardano.

4. Asset Management. DeFi offers you the opportunity to take cryptocurrency assets under management. For example, these can be automated portfolios, lending platforms, and decentralized indexes. Examples of such media include Yearn.finance, Aave, and Compound.

5. Lending and Borrowing. DeFi easily allows users to lend and also borrow, all directly and without intermediaries. This opens up additional opportunities for users for financial inclusion and bypassing geographical restrictions. Examples of such platforms include MakerDAO, Compound, and Aave.

These are just some of the list of available DeFi components that each of you can use in your daily life. There are a large number of other financial tools for innovative opportunities and solutions in different areas, as well as for investing in cryptocurrency.

Risks in using DeFi

Despite DeFi's extensive capabilities and use in various financial applications, it, like any cryptocurrency, is subject to risks. Among them, are security threats and hacker attacks, and sometimes vulnerabilities in smart contracts. This can cause you to lose money if you act carelessly. 

DeFi is subject to regulatory risks due to the lack of clear regulation, as well as high volatility, just like cryptocurrency. Your investment is directly dependent on the market rate and can fluctuate in value. 

And don't forget that there are no centralized institutions in this system, so if you lose access to digital assets, no one can help you restore it and you can lose your finances.