Topic 1: Defining DeFi - ClutchWallet

Topic 1

Defining DeFi

Introduction

When ordering a Venti Vanilla Latte, skinny with oat milk and an extra shot, from your perspective, it’s a quick and easy transaction. You ask for a drink, the cashier subtly gives you side-eye, tells you the total, and you swipe your card. What you may not think about is that when you swipe your card, a financial institution must approve the transaction. When agreeing to use this financial institution, they can approve or pause any transaction and record it in their private ledger. With DeFi, you don’t have to think about financial institutions because there is no financial institution. The goal of DeFi is to eliminate middlemen from all transactions.

DeFi[ne] the relationship?

DeFi is decentralized finance and the umbrella term for peer-to-peer financial services. It uses public blockchains and operates primarily on Ethereum. DeFi uses smart contracts to create protocols for decentralized applications (dApps). Smart contracts are self-operating computer programs that perform a function when certain conditions are met, and they can perform the function through dApps.

Let’s break it down “Friends” style. Think of a smart contract as Rachel telling her bf, Ross, that they should take a break. Ross is a dApp now programmed with the protocol that he is on a break from Rachel and must defend his subsequent actions until the end of time. So when anyone confronts him about sleeping with someone else the same day, he is conditioned to say…DeFi is thankfully more logical and as easy as a smart contract stating when Jane receives 20 Eth, Elizabeth receives a Boss Beauties NFT.

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DeFi is thankfully more logical and as easy as a smart contract stating when Jane receives 20 Eth, Elizabeth receives a Boss Beauties NFT.

What is the difference between DeFi and Web3?

Web3 is all-encompassing, while DeFi is a subsector of Web3. Web3 includes all the open, public, and decentralized blockchains, while DeFi operates through smart contracts primarily on Ethereum. TLDR: DeFi is the financial system within Web3.

Why choose DeFi over “Regular?” Fi?

“RegularFi” is centralized finance, or “TradFi,” run by third parties such as banking institutions. Aside from no annual or banking fees, with DeFi, you always hold your money in your secure digital wallet instead of storing it in a bank. Furthermore, DeFi is accessible to anyone with an internet connection so there’s no need to search for bank branches in your area. You can also get your transaction done in seconds or minutes rather than days.

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What makes it decentralized?

In DeFi, there is no man behind the curtain. The foundation of DeFi is blockchain technology which uses computers and smart contracts, not a person, to authenticate transactions. These computers remove the need for centralized entities, like banking institutions and the people that work for them.

Here’s a story to help put things in perspective. Sarah wants a loan Sarah wants a personal loan. She goes to the bank, and the bank lists all of the criteria that need to be assessed before she can obtain a loan. This includes her credit score, debt-to-income ratio, capital, and whether she can put up collateral. The bank needs Sarah’s personal information like a social security number (U.S.) and employment information to evaluate her reliability. Unfortunately, Sarah wasn’t always responsible with her money in her college days, so she has a few black marks on her credit. She gets denied the loan.
The Problem Sarah can’t obtain her loan because the bank thinks she’s not reliable even though she’s been out of debt for years. She also had to relinquish her personal information to be evaluated for a loan that the bank ultimately decided not to give her.
The Solution Remove banks that make loans inaccessible to qualified people. The only requirement is collateral. From a global perspective, there are currently 1.7 billion people who are unbanked because they don’t have access to a bank account. Sarah doesn’t have to go to multiple bank locations and hear the same news. DeFi is all online and makes financial services accessible at your fingertips. Aside from loans, there are many DeFi Financial Services you can take advantage of. DeFi Financial Services If you take the current financial services and decentralize it, you get DeFi financial services.

Lending – Anyone can be a lender. You can loan people money and have a public ledger with a record of the lending.
Borrowing – You can obtain a loan directly from someone in an instant without paperwork or credit checks.
Trading – Similar to buying and selling stock through a brokerage, you can make peer-to-peer trades of crypto assets.
Saving – This is the same as a savings account with much better interest rates than banks.
Buying Derivatives – Like stock options or futures contracts, you can make long or short bets on certain assets.

Is DeFi Safe? We have covered the definition of DeFi, put things in perspective and listed services. But this is a new and developing technology, so is it really safe?” Investing in DeFi can be risky, especially for crypto newcomers who may find it difficult to discern good projects from bad. An example of a bad DeFi app is meme coin YAM, which crashed and went from being a $60 million to $0 project in 35 minutes – The issue was caused by a bug which caused issues with its on-chain governance feature. DeFi safely relies heavily on how well the smart contracts that power such applications are written. Typically, projects will engage Smart Contract auditors to find bugs before applications are launched to the public, and for on-going smart contract maintenance and safety, project’s will host bug-bounty competitions, and encourage people to regularly check their open-source code.
To Recap DeFi is an emerging financial system that allows more people to access advanced features of Web3. It’s open, decentralized, and permissionless. Best of all, there’s no wait. You can get approved for DeFi loans instantly without worrying if a bank will approve or deny them. This being said, it’s important to do your research because some DeFi projects are more vulnerable to hackers than others. Next, we’ll look at the history of DeFi.

Key Terms

Written By

Bec Jones