What is DeFi? Why is it trending among Cryptocurrecy investors? Indeed, recently the number of cryptocurrency investors are on the rise. Bitcoin, Ethereum, Dogecoin, Litecoin, Matic, and Ripple are some of the most popular coins of all cryptocurrencies currently available.
If you are someone who likes to invest in the world of Cryptocurrency, you must be familiar with the term DeFi, right? DeFi is the latest trend in the Cryptocurrency world that attracted the interests of institutional money and professional money managers.
So, what’s all the excitement for? Let’s take a closer look.
Definition and Background:
DeFi stands for Decentralized Finance. It is an open financial system, run with Smart Contract technology. Smart Contract itself is one of the functions provided by Blockchain. Programmers use it to create applications that run entirely on the blockchain. Generally speaking, DeFi runs on the Ethereum blockchain. The term “Ethereum” can also refer to ETH, the crypto currencies that has the second largest market capitalization after Bitcoin. Smart Contracts allow DeFi to run automatically without a third party. They are not dependent on central financial intermediaries such as brokers, exchanges, or banks.
You can see DeFi as a general term that describes financial products that’s based on blockchain technology and cryptocurrencies. Smart contracts are the software & coding used to record and execute each of the investment activities. Becasue of the lack of intermediaries, DeFi is faster, safer, cheaper and more efficient in providing financial services.
In comparison, in the traditional/classical financial world, large financial institutions have tight grips on various financial activities. For example, credit card companies like Visa or Mastercard company dominates consumer transactions market. In international money transfer, the SWIFT system dominates. In contrast, in DeFi, crypto asset flows are not controlled by single organization, and are automatic, transparent and can be monitored by the public.
A DeFi user can transact with other users without any authority having the right to stop, cancel or suspend the activity.
“The annual percentage yield (APY) is the real rate of return earned on a savings deposit or investment taking into account the effect of compounding interest.”
- APY is the actual rate of return one can earn in one year if the interest is compounded.
- Compound interest is added periodically to the total invested, increasing the balance. That means each interest payment will be larger, based on the higher balance.
- The more often interest is compounded, the better the return will be.
Types of Decentralized Finance Products
Here are some crypto assets used in the Decentralized Finance network.
Stablecoins are often used as the denominating assets in DeFi investment plans. For example, when you buy mutual funds, it is often denominated in US Dollar or Euro or your home currencies. Stablecoins are cryptocurrencies but designed to peg the value of a fiat currency. For example, USDC & USDT are stablecoins 1-to-1 pegged to US dollar. EURS is a stablecoin 1-to-1 pegged to Euro. Stablecoins easily provide a gauge of value familiar to everyone. Thus, they help to coin the money value of all kinds of crypto assets.
DeFi products denominted in stablecoins normally require buyers to pay in stablecoins in exchange for interest like returns.
2. DeFi Lending
Lending is the most popular and easier products. It is the same as conventional financial lending, where banks or creditors will lend their money (or other assets) to the debtors and collect interests as earnings.
In conventional bank lending, the interests are based on the credit score of the borrower and determined after negotiations and signing of paper contracts. However, in DeFi, the interests are calculated based on real-time demand and supply and executed by smart contracts automatically in real-time. Some providers of DeFi lending use softwares to automatically looking for the best interests everywhere in the market and auto-switch to the higher borrower to earn higher interests.
Again, similar to conventional bank lending, the borrower need to pledge their assets to the lender. In case the borrower cannot pay back all the borrowed assets in time, the lender will take possession of the pledged assets. Assets pledged are often stablecoins or ETH.
3. Options Market
Some of the DeFi investment plans will the money in buying options. DeFi options work very similar to the options contract in conventional stock market or futures market. An option contract is basically a bet against an asset’s future price, and depends on how the price moves, a buyer of the options contract can either lose or win. With options contract, futures, and other financial contracts, Crypto traders can design complicated financial products with high leverage, high risk and extremely high return. Some of the DeFi provider will diversify their products by putting some money in the relatively safe lending products and others in high risk Options market.
Why is DeFi the future for financial market?
1. Fast Growth
The ability to execute in real-time and skipping the pro-longed negotiations and pro-longed contracting process, is too attractive. Institutional investors have been rushing to DeFi and offering their customers DeFi products. In 2021 alone, Goldman Sachs, Citibank and JP Morgan have all announced dedicated departments for crypto trading and DeFi investments. The Total Value Locked (TVL) which means the total value invested in DeFi has increased from 0.5B in May 2020, to 80B in May 2021. A YoY growth of 160 times. The high growth is not missed by investors and will spur more growth in the market.
2. Easy Cross-country Investment
Smart contracts are borderless. Anybody from any country can easily invest with any good traders in any countries and put money with them. This is not possible in conventional financial world, where financial products are only for local market. Investment funds provided by banks might offer customers the access to other country’s stocks. Behind the scene, it takes months of negotiations and contracting processes, and very high transactional costs to execute. There are so many banking personnels and systems need to be paid. These are all eliminated by in the DeFi world, fees are paid for the network and that’s it.
3. Privacy Protection & Independence
In the crypto world, smart contracts govern everything. As long as you agree to the contract, no one can stop you from investment or shutting your transaction down. So in a situation of a dictatorial government and a bad economy, DeFi users can move their assets to and from DeFi to protect them. For example, in Venezuela, where many people move their money to Bitcoin to protect their wealth from currency manipulation or unusually high inflation.
Traditional Vs. Decentralized Finance
The biggest difference and most crucial difference is the DNA. DNA of traditional finance is centralization, controlled by a power organization like government or a central bank. For Decentralized Finance, the DNA is decentralization. Let the computer codes do the job. The system constantly looks for the best return and the fastest execution and protects the identity of everyone in the market. If control is the keyword of traditional finance, then efficiency is the keyword for decentralized finance.
DeFi brings democratization of financial services. Everyone, regardless of gender, race or country, as long as they have internet access, can join and interact. This makes DeFi a great choice for a global implementation. Transparency and flexibility are some of the other advantages over trational finance.
Decentralized Finance has started since 2013 and is often referred to as open finance or open financial services. Recently, the drastic increase in DeFi was also caused by the acceptance of regulators. The US Securities and Exchange Commission, for example, approves Ethereum-based managed funds. Big players in the financial industry such as JP Morgan and ANZ are also starting to use blockchain to integrate into their systems.
So, do you want to start investing in DeFi today? Coinomo has several investment products handpicked by us, that offers up to 13% APY with minimum risks, compared to traditional banking interests of about 2.8% per year.
Try it today and beat inflation today. Let your money earn for you.