The term “DeFi” has made its way from an ideal in the crypto industry to a point of interest in mainstream media coverage. But what is DeFi, and why is it such an integral part of cryptocurrency? Let’s take a look.
What Is DeFi?
Decentralized finance, or “DeFi,” is an umbrella term for the ecosystem of applications working toward the decentralization of finances.
What this means is that rather than having an intermediary body (like a traditional bank) at the center of transactions, two parties can connect and make exchanges entirely on their own.
The appeal of DeFi is that traditional banks and intermediaries create time-consuming, expensive, and unnecessary steps in the exchange process. Decentralization aims to fix this and develop a more free and fair financial market.
How Does DeFi Work?
Many elements make up decentralized financial systems, but above all else, they require infrastructure and currency to operate. With financial services for fiat currency, for example, traditional banks are the infrastructure and fiat money is the currency.
DeFi requires similar features to work. The infrastructure element is satisfied through platforms like Vauld, and crypto is used as the currency that users can openly trade, lend, or borrow. In this way, decentralized financial systems are very similar to traditional banks.
The differences, however, are what help DeFi innovate and stand apart from banks in the modern day.
No Third Party
As we mentioned, the lack of an intermediary is at the heart of what DeFi is. The freedom that an individual can have with their finances is also linked to the unbeatable rates and wealth-building opportunities that exchange platforms offer consumers — more on this in a bit.
In the world of DeFi, the middleman is essentially cut out so people can have more autonomy over their financial well-being.
But how are these transactions verified?
Rather than use a central authority, DeFi transactions rely on smart contracts. These automatic and enforceable agreements significantly expedite the process and remove the many costs associated with third-party exchanges.
And smart contracts have come a long way in a short amount of time. Since their initial development in DeFi just a few years ago, they have become one of the fastest-growing aspects of crypto and decentralized finances as a whole.
One of the biggest questions that comes with DeFi is its safety. Without a neutral third party, how is the security of these countless transactions maintained?
The immutability of DeFi is a key element that lends to a safe environment for exchanges to occur. This means that the ledger cannot be changed or manipulated without someone noticing.
With transparent and well-monitored activity, along with a list of financial benefits, it’s no wonder that so many individuals are considering decentralized financial systems. And, once they’ve transitioned, the perks only continue.
How To Use DeFi
Using DeFi can be as simple or complex as a user wants it to be. While many use it in a similar way to a savings account at a traditional bank, others take advantage of unique opportunities that only decentralized financial services can provide.
Here’s a list of just a few options offered by most exchanges.
Earning crypto and storing it in an online wallet is one of the most common ways to use DeFi. Much like people store money in a bank, saving crypto with a company like Vauld makes it easy to earn some of the highest rates available.
The ability to store crypto in a safe place is an unbeatable service, but keep in mind that not every platform takes the same precautions when it comes to your crypto.
Here at Vauld, we ensure the safety of customers’ assets by moving funds from the investor’s wallet to a centralized lending pool that’s insured for $100 million in BitGo.
When choosing where to deposit your crypto, also ask which security features are protecting your crypto.
A step beyond saving, lending gives users agency to earn more with their assets. For example, the savings rate for Bitcoin at the time this article was written is 4.6%. A user interested in a fixed deposit rate, however, can lock in their funds and earn over 2% more.
Lending crypto lets you get the most out of your investment. Comparing it to a traditional bank, it’s similar to a certificate of deposit, but the rates of the two could not be more different. While a CD will earn less than 1%, certain crypto receives rates as high as 13%.
These vastly different rates are one of the many reasons why people are switching to DeFi.
Now that we know you have multiple options to increase your earning power with DeFi, what else can you do? Borrowing is yet another way that crypto exchange platforms have decentralized a service known for intermediary parties.
In a financial emergency, crypto holders may quickly turn to sell their cryptoassets to collect necessary funds. Borrowing with Vauld makes it easy to take out a loan with your crypto rather than sell it.
Instead of going through the typical, arduous loan process with the bank, getting a loan with DeFi is convenient and oftentimes immediate. Users simply lock in their crypto as collateral and pay down the loan and the interest to earn it back.
Traditional banks use third parties to conduct lengthy background checks and might still deny a loan. But crypto exchange platforms only need to make sure that a user has the proper funds to take out the requested amount before approval.
At Vauld, our competitive rates are also available for borrowers. It’s easy to check current rates and take out a loan at interest rates in the single digits instead of what might otherwise be upwards of 30% and higher.
Vauld customers can exchange their crypto for other tokens and fiat currencies or even diversify their investments through trade-only tokens.
When looking for a DeFi platform for trading purposes, it’s important to be sure that they have a long and diverse list of tokens to trade. Also, check that the platform includes information like minimum trade amounts and takers fees for certain pairs of crypto trades.
Are There Risks With DeFi?
There are inherent risks that come with a decentralized financial system. Some of these risks are due to technical issues, while others depend on the individual user.
Smart Contract Risks
Smart contracts are designed to remove intermediaries, but just because they aim to fix a problem with modern finances does not mean they are without their own downsides.
A major risk of smart contracts is compromised cybersecurity. A potential error can impact security, result in hacking, and cause financial damage.
To prevent this, platforms will often enlist a security firm to run a code audit or bug bounty program that allows for a thorough review of their security. Above all, always ask what measures your platform is taking to best protect your assets.
For now, many DeFi transactions operate on a “buyer beware” model. While traditional banks can usually fix errors and transactions sent by mistake, DeFi is not as forgiving. Sending money to the wrong address often means not getting it back.
So, it is entirely up to you to stay cautious of where you’re placing your funds. Without the FDIC insurance that banks have, crypto exchange platforms are limited in how they can offer complete insurability of funds. Still, the best platforms will have some form of protection.
The risk of uncertainty and market volatility means that no one knows for sure what the future of DeFi holds. Especially when it comes to regulatory uncertainty, decisions on how or if DeFi is regulated will have a huge impact on decentralization moving forward.
The Future Of DeFi
The world of DeFi is one that many hope will create more freedom and fairness when dealing with finances. At its best, it could entirely disrupt the way we interact financially, but the risks pose considerable threats to DeFi’s growth.
DeFi’s future is dependent on several factors, one of the most important being the development of its regulatory framework. While many are hopeful, there is a lot of work to be done before decentralization can truly take off.
At the very least, choosing DeFi today means receiving rates on lending and borrowing that are far better than someone can get from their bank. Although it comes with risks, there are ways to mitigate and avoid the downsides while making the most of the benefits.
For the best DeFi platform, choose Vauld for all of your crypto needs. Whether you’re saving, borrowing, trading, or simply exploring the many possibilities of DeFi, we offer competitive rates and a seamless, unbeatable customer experience.