A Beginner’s Guide to DeFi

July 23, 2022

Mention cryptocurrencies to anyone outside the financial industry and they’ll most likely think of Bitcoin. They’ll know it’s a currency — a kind of strange, digital one — and they’ll probably know that its value has been a little unpredictable of late. However, for people to understand the full advantages that cryptocurrencies like Bitcoin have to offer, it’s important they recognize what separates cryptos from traditional currencies. They need to understand the fundamentals of DeFi.

The Decentralized World

DeFi — short for Decentralized Finance — is a financial system in which there is no central body governing or controlling the transactions. Unlike traditional banks that act as third-party facilitators, DeFi transactions occur directly from person to person (peer-to-peer, as it’s called).

Historically, people have placed their hard-earned money in bank accounts that pay a level of interest. The bank then takes this money and lends it to other people or businesses at a higher rate of interest than they’re paying the investor, with the bank keeping the difference.

However, in the DeFi world, instead of you giving your money to a bank, you place your cryptocurrency — be it Bitcoin or any of the others — into a shared pool that borrowers can draw from. These borrowers stake their own cryptocurrency as collateral, meaning that investors will be able to sell these assets in the event that the borrower doesn’t pay off the loan.

Most importantly, this entire process occurs peer-to-peer without any central body overseeing the transaction. Using clever bits of computer code known as ‘smart contracts’, the entire process essentially governs itself, with interest rates decided by market forces and the particular coin you’ve invested in (if you’ve invested Bitcoin, the interest you’ll earn will be in Bitcoin). What’s more, with lenders maintaining full control of their assets at all times, it’s an incredibly safe and profitable way to invest money.

The DeFi Boom

The frictionless nature of the DeFi world has seen it grow to phenomenal proportions. With a market cap of $2 trillion, there are currently over 260 million people worldwide using crypto wallets (the technology that allows people to gain access to the crypto markets).

That said, the crypto world isn’t without its issues. The very fact that there’s no central governing body means that anyone, no matter what kind of criminal or money-laundering background they come from, can get involved in the process. Needless to say, this can cause problems for certain financial institutions who don’t really want to be lending money to ‘Miguel The Jackal’ no matter how much collateral he provides.

To solve these issues, many DeFi markets are introducing what are known as ‘Permissioned Pools’. These pools operate in much the same way as standard DeFi pools, however, participants need to be whitelisted (a vetting process by which checks are performed to authenticate users). The anonymity of all involved is still maintained, however, all parties can rest assured that they’re dealing with bona fide individuals and organizations.

And there you have it — the basic principles of DeFi. At Escrypto, we’re creating payment solutions based on these principles that allow users to transfer funds efficiently and safely. If you’d like to know more about the services we offer, you can contact us at the following link.