The blockchain world has developed lingo all its all. As a result, it’s not uncommon for newcomers to feel completely overwhelmed when they’re first hit with terms like DeFi, layer 2 solutions, and blockchain protocols.
Seriously. It’s enough to make you feel like a 4th grader in a college algebra course.
In the presence of blockchain wizards, it’s tempting to nod, smile, and pretend you know WTF is going on. But if you want to know what words like DeFi mean, you’ve come to the right place. We’re about to break things down in an actually understandable introduction to decentralized finance (DeFi).
What’s the Deal With DeFi?
To give a crap about how DeFi works, you first have to understand what it’s designed to do. It all goes back to banks. Yep, banks.
When you think about it, banks have always had a shitload of power. Where is most of your money right now? Probably in a bank.
Want to sign up for a credit card or take out a loan to buy a house or car? You’ll probably have to pay a giant financial institution an obscene amount of interest to do it.
Centralized banks have traditionally been the official guardians of money. They can slap you with a late fee, refuse to give you a loan, or charge you fees to use their services. And we all accept it, because what other option do we have?
DeFi aims to become that other option.
DeFi: Ain’t Nobody Got Time for Banks
Decentralized finance is basically the antithesis of everything centralized banks stand for. DeFi’s goal is to eliminate the need for banks by allowing anyone to store, control, and use their assets however they please.
Instead of a bank account, you can now sign up for a secure digital wallet to store assets like cryptocurrency. Then, if you want to make or receive a payment, you can do it in seconds without relying on a third-party bank.
Want to send money to someone halfway around the world? Go for it – without having to worry about foreign transaction fees. Want to open a business? DeFi allows merchants to accept customer payments without paying debit card processing fees.
It even lets users lend or borrow money at a rate they can negotiate.
How DeFi Uses Blockchain Technology
Sound cool? It is. But how the hell does DeFi aim to pull off this utopian vision of financial freedom?
Okay, so this is where some big words come in. But don’t panic because we’re going to break them down too.
DeFi is convenient and secure because it’s built on the same blockchain technology that makes cryptocurrency work. DeFi protocols are usually built on blockchains like Ethereum or Avalanche because they have a function called smart contracts.
When two parties make a transaction on one of these blockchains, it’s verified by validators who make sure it’s legit.
Once the transaction is completed, a digital record (like a receipt) is encrypted into a “block” for all time. New transactions are recorded in additional blocks, which are then “chained” to the ones before them. Hence the name blockchain.
All these blocks are then recorded in a vast distributed financial database. This database contains a record of all transactions ever made on the blockchain. Once a block is added, it can’t be changed in any way without affecting all the blocks that follow it. For this reason, a blockchain is nearly impossible to hack or alter.
The Pros and Cons of DeFi
From transaction speed and accessibility to staking and lending, DeFi has plenty going for it. But don’t cut up all your debit cards just yet.
Yeah, DeFi has loads of great potential. But it’s still an emerging technology with plenty of kinks left to work out.
While blockchains are incredibly secure, that doesn’t stop some scammers from attempting shady shenanigans. For example, some may attract buyers before executing a dreaded “rug pull.” Others may try to gain access to a user’s funds by stealing their wallet keywords.
The truth is, there is no completely foolproof financial system. However, the good news is that blockchain technology is not as anonymous as some people assume.
Remember the whole blockchain ledger we talked about above? It allows law enforcement to trace transactions to the beginning of crypto history.
Some of the more common issues with DeFi are things like scalability. The easiest way to understand this issue is by picturing way too many people all wanting to use the same checkout line or highway.
The more congested a blockchain gets, the slower and more expensive it is. But protocols like Layer 2 solutions have now been invented to help solve this issue.
Last but not least, for DeFi to really take off on a global scale, it’s going to have to be much more user-friendly. Anyone with a government ID can now sign up for a bank account online in a few minutes.
But many people’s eyes still glaze over at the mention of words like “DeFi” or “blockchain.” While more people are getting into crypto daily, history has shown that change doesn’t always happen overnight.
Okay, so the DeFi revolution may arrive at a slower pace. But at least now you’ll know WTF’s going on when it ultimately comes.