DeFi for Dummies — Part 1 of 1
De-fi originated in august 2018. To understand decentralized finance, we need to understand CE-FI(centralized finance).
All the transactions go through central authority, usually backed by banks, financial institutions, private institutions etc.
For eg- Traditional investing ways, Current banking system.
Crypto is all about decentralization of traditional systems, processes and services.
De-fi came into existence because-
- People thought the banking & financial system should also be decentralized.
- People wanted to be their own bank.
- People wanted to have control over their money.
WHAT DO BANKS DO?
Banks are mainly used for financial transactions since they provide services like lending, sending, receiving, borrowing money etc.
Banking is important, banks are not — Bill Gates
This statement clicked to a lot of people.
But with being your own bank comes lots of responsibilities.
It has its pros and cons, it’s a double edged sword.
- Less paperwork, compliances etc
- No racism, favoritism etc.
- No corruption
- Better Liquidity
- Less transaction fees unlike paypal etc.
- No security measure fees etc
- High average returns of 10%-40%
- Can control our own money.
- Services like Trading, lending, borrowing, insurance, providing liquidity, staking, farming etc are there in DE-FI.
- Responsibility of managing our own funds
- Risk of losing funds to cyber hacks, forever
- Nobody’s liable to pay you anything if funds are lost
- Have to manage plenty of risks of CE-FI.
- No element of trust like provided by banks
- Heavy computing required, so high transaction fee over ethereum.
Simply put, “You can’t have the best of DE-FI without having the risks of “CE-FI” .
Because in Ce-Fi, we are putting trust in banks and banks manage that trust part for us.
They are responsible to repay if something happens to our money which would not be the case in DE-Fi, since there’s no central authority.
Banks provide us with an element of trust and service and in return charge us for it which is fair.
But in DE-FI, you become your own bank and have to take all these responsibilities on yourself.
Since there’s plenty of risk, therefore the rewards are high in DE-FI.
Things to understand -
- Bank account no in CE-FI = Wallet address in DE-FI
- Netbanking login & password in CE-FI = Seed phrase in DE-FI
- OTP in CE-FI = Private keys in DE-FI
This is just for reference and context basis.
If you lose your seed phase and private keys, your money is gone forever !!
Therefore, DE-Fi is not for people not willing to manage the high risk/ high reward.
To give you a perspective-
- Poly network had a $610 million hack, thankfully, the hacker returned the money.
- $745K Autoshark hack.
If you don’t understand the tech in DE-FI, you are going to lose the money to someone who does.
Core of DE-FI consists of -
- Decentralized exchanges (DEX)
- Decentralized apps.
- Decentralized protocols.
Don’t worry, we’ll explain them to you….. but first….. let me take a selfie…
Let’s understand how banks make money first.
HOW DO BANKS MAKE MONEY?
Banks make money mainly by borrowing money at a cheaper rate and lending that money at a higher rate.
Banks are run with the help of computers, people and diff security measures etc.
Transactions here are recorded on computers, physical passbook etc.
Problems that arises with banking system-
- Banks may face liquidity issues if all lenders come asking to return their money.
- Lot of favoritism, corruption and scams are there which happen because of poor decisions made by banks.
- Average Interest rate provided= 6%pa, which is even less than inflation.
HOW DE-FI WORKS?
DE-FI works in the same manner as the bank, the only difference is
- It’s being run with immutable autonomous smart contracts.
- Transactions are recorded on a digital ledger i.e blockchain.
- There’s no racism & no credit score/income check before lending money.
Things to understand in image above -
- Y is always greater than X, in order for DE-FI to make profits.
- DE-FI stores reserve funds in the form of total value locked(TVL) etc to have good liquidity.
- Liquidity of DE-FI is greater than that of CE-FI.
- Interest provided by DE-FI is also greater than that of banks i.e 10%-40% on average.
These high returns are not sustainable.
They’re there right now because the number of users in DE-FI is less right now.
If users in DE-FI increases, then-
- Total value locked (TVL) would increase.
- Increase in TVL would increase liquidity.
- Increase in liquidity will lower down the fancy interest rates DE-FI offers right now.
We can’t use our fiat currency directly on blockchain, so therefore stablecoins were created.
They are pegged to fiat currency to do the transactions on blockchain .
For eg- 1USDT = $1 USD.
Currencies over blockchain are essentially stablecoins only.
There are different types of blockchain and each blockchain has their own unique stablecoin to do the transactions.
- USDT- Ethereum chain
- BUSD= Binance smart chain
- UST= Luna Network
- FUSDT= Fantom chain
If you put $1 million into de-fi, you get 1 million USDT.
You can spend these USDT on blockchain or get $1 million back anytime.
Value of 1 USDT will always be $1
We hope you’re clear on stablecoins. In next part, we’ll talk more about DeFi and how you can setup your own wallet and get started.
You want to learn how to generate trustfree ROI then you may like what we’re doing at Fidaro.
Here are some useful links to save and reference. Let’s go and help you achieve your goals.