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Many people who know about cryptocurrency also know a bit about DeFi. But they may not realize just how huge the potential gains in DeFi systems are. For example, one of the largest DeFi markets was worth about $1 billion one year ago and is now worth more than $17 billion.
Just like other parts of the cryptocurrency game, there are huge gains happening all the time. However, there are a lot more people competing to make money by investing within the cryptocurrency market. The DeFi market has fewer competitors, so you have a better chance of being able to outmaneuver people if you learn enough about it.
Of course, that all starts with knowing what is DeFi. You have to understand the mechanism behind these systems so that you can predict which ones will make you the most money.
Put simply, the term DeFi refers to a long list of financial services that can be provided without any central authority, but there is a lot more to know about it than that.
Read on to learn all about DeFi markets and how they work.
What is Decentralized Finance (DeFi), Exactly?
Decentralized finance (DeFi) is a blockchain-based approach to finance that doesn’t require a centralized authority to execute transactions. Instead, it uses smart contracts—that is, programs that run when predetermined conditions are met—to execute transactions. The most commonly used DeFi network at this time is Ethereum.
With DeFi, the markets are always open and there are no centralized authorities (such as companies or individuals) who can block payments, deny access, or decline a transaction. This is revolutionary approach.
As defined by DefiPrime, “DeFi is the movement that leverages decentralized networks to transform old financial products into trustless and transparent protocols that run without intermediaries.”
The site currently lists 243 DeFi projects, of which an astounding 220 (90%) are built on Ethereum.
DeFi Crypto Meaning
The word DeFi is short for decentralized finance. It is a term for a series of new financial tools that are built on the blockchain, just like cryptocurrencies.
That means that, just like with cryptocurrencies, the markets that decentralized financial systems are run on are not subject to control by any single entity. Instead, DeFi gives information about every transaction to many different entities. It takes that basic idea from the blockchain.
The difference with DeFi is that instead of being used only for transactions, DeFi allows users to cut the middleman out of financial applications that have traditionally required them, such as crowdfunding, insurance, and loans, for example.
One of the main things that people use decentralized finance tools for is decentralized exchange. These exchanges allow people to exchange one kind of cryptocurrency for other kinds of currencies. They also allow you to exchange for regular currencies like United States dollars.
There are a number of applications of this system that allows people to make money. We will discuss those and how to invest in DeFi in a moment.
Is Bitcoin DeFi?
You can probably guess at this point is that Bitcoin is not an example of decentralized finance. Rather, Bitcoin is a cryptocurrency. Decentralized finance is all about platforms that allow you to trade between cryptocurrencies.
That means that decentralized finance is not itself a cryptocurrency. However, there is one nuance to add to this summary.
Many decentralized finance exchanges do offer their own cryptocurrency as well. When you buy and sell with their exchange, they award you with tokens from their cryptocurrency.
You might ask, why would they do this? The answer is that they want as many people to use their exchange as possible. That is why they are willing to more or less pay you to use their exchange.
That means that if you can find a decentralized exchange that you think will become popular over time, then you can use it to receive tokens in its currency, wait for that currency to go up in price as the exchange becomes more popular, and make a profit in the future.
How Can Decentralized Finance Make You Money?
As we discussed before, there are a few ways to use decentralized finance to make money. There is something called yield farming on the decentralized finance exchanges.
Yield farming is a lot like a bank. You deposit your money in a yield farm and you get paid interest for doing so. The reason that banks are willing to provide interest payments to people who store their money in them is that banks can use their client’s stored money to issue loans on which they get paid interest.
Likewise, when you put your money in a yield farm, you receive payments, very much like interest.
Yield farming can also be used in more complicated applications, such as investing on the margin. With margin investing, you borrow money from a broker so that you don’t have to contribute all of the funds required to buy a cryptocurrency position. With this approach, you increase both your risk (potential downside) and your reward (potential upside).
If you feel confident that a specific cryptocurrency is about to rise in value, then you can use this approach to supercharge your returns. Of course, if you are wrong, you will supercharge your losses.
For whatever reason, lots of people think they can predict the market. That means that yield farming is a pretty popular application of decentralized finance.
We discussed before how yield farming is similar to banking. The difference here is that while banks use your stored money to make loans, yield farms use your stored money to provide liquidity. Having plenty of currency on hand means that they can help speculators to shift rapidly between currencies.
Investors are willing to pay for the opportunity to exchange their cryptocurrency quickly, so yield farms are willing to pay you to provide them with the liquidity they need in order to provide investors with easy access to the cryptocurrencies that they want.
If you are not doing anything else with your cryptocurrency, you could consider using yield farming to collect interest. At present, nearly all yield farming transactions are completed using the Ethereum blockchain, but this could change in the future.
To be clear, buying Ethereum (ETH) isn’t yield farming. However, lending out ETH on a decentralized exchange and receiving rewards from doing so is yield farming.
The Future of Decentralized Finance (DeFi)
I hope you learned about what DeFi is and why it’s important to the future of humankind. Cryptocurrency is a recent technology, which means there’s is a lot of room for exciting new innovation.
Similarly, decentralized finance is a recent phenomenon. This concept of being able to execute financial transactions without a centralized point of control has the potential to reduce costs, improve transaction speeds, enhance trust and transparency, reduce corruption, enable global exchange—and most notably, transform finance as we know it.