The Ultimate Guide to DeFi

Decentralized Finance, known in the world of Web3 and blockchain technology as DeFi, is an increasingly popular way for people to trade digital assets anonymously using totally decentralized blockchain technology. You don’t have to trust a centralized crypto exchange with your digital asset custodianship or personally identifiable information, nor a traditional financial institution to facilitate a transaction.

In addition, due to the smart contracts DeFi protocols are built on, users can rest assured that their transactions are protected by the immutable state of the blockchain used to develop the protocol.

In this guide, we’ll provide a broad overview of decentralized finance, or DeFi, along with how you can begin learning about and investing in DeFi protocols.

Decentralized finance (DeFi) is an alternative to traditional centralized finance that operates without any intermediaries or third-party and is accessible to anyone in the world with an internet connection 24/7 through peer-to-peer digital exchanges. Commercial banks and other financial institutions have control of your financial assets to a degree, can freeze assets and deny transactions, and require personally identifiable information to use their services.

While centralized institutions have security features, laws, and other protocols in place to safeguard customer assets and data, because they retain that information in centralized databases, your data is potentially at risk to enterprising hackers.

With DeFi, users are not required to disclose personal information, are custodians of their own digital assets, and don’t need to trust anyone or any institution. Because of DeFi protocols’ smart contracts, users are assured that the protocol will do what it says it will. This lack of human intervention often makes DeFi transactions much safer than traditional financial services and cheaper, with faster transaction settling times.

The overarching goal of DeFi is to create and facilitate a trustless, permissionless financial market open to anyone in the world with an internet connection. Transactions remain unbound by national borders or government regulation and don’t require the permission of an intermediary to send and receive funds.

While there are other uses for DeFi, peer-to-peer (P2P) financial transactions are the most popular use case. In P2P DeFi transactions, two parties agree to exchange cryptocurrency for goods and services, such as a loan, and an algorithm matches the user requesting the loan with a peer that meets their needs. Transactions are then completed on a decentralized application (dApp).

DeFi allows two parties to negotiate interest rates directly with one another and typically entails lower fees than traditional finance. In addition, due to the immutable nature of blockchains and the smart contracts that run DeFi, it’s a secure method for anonymous users to send funds globally. Smart contracts publish each transaction on the corresponding blockchain used to make the transaction, providing transparency that protects the integrity of the blockchain, but users’ identity remains anonymous.

Internet knowledge bases, blogs, and guides like this are great places to begin educating yourself in decentralized finance. The more you know about DeFi before you begin investing, the better off you’ll be, but it’s a good idea to set up a DeFi wallet and begin making low-volume trades once you’ve got a basic understanding of how DeFi works. There’s no substitute for hands-on experience.

Before you can begin trading digital assets peer-to-peer on decentralized exchanges (DEXs) and other decentralized applications (dApps) like you’ll find on the Uniswap DeFi protocol ecosystem, you’ll need to set up a non-custodial DeFi wallet. Custodial wallets, such as Coinbase offers, are centralized and require users to set up a username and password and provide other personal information. While this is often easier for beginners in the crypto and blockchain world, it also results in your digital assets being managed by a third party, restricting your autonomy.

Unlike custodial wallets, a DeFi wallet is non-custodial, meaning each user controls and is responsible for managing their digital assets. Exchanges such as Crypto.com offer both custodial and non-custodial wallets.

Users opening DeFi wallets through services like Crypto.com create a passcode and receive a twelve-word recovery phrase that, if lost or misplaced, is totally lost. You won’t be able to recover your digital assets, so it’s essential to save your passcode and recovery phrase in an offline location, unable to be accessed by anyone else, such as a physical notebook or flash drive. There isn’t a customer support representative that can help you if you lose your private keys or recovery phrase as you’d have with a centralized exchange like Coinbase or while using the centralized brokerage of the Crypto.com app that acts as a custodian for your cryptocurrencies.

After you’ve set up your DeFi wallet, the next step is acquiring blockchain tokens and coins to begin trading. Most DeFi protocols allow users to connect credit or debit cards to purchase tokens and coins. Alternatively, you can transfer or receive digital assets from an existing account — whether that’s another user or sent from one of your other wallets.

Now that you’ve funded your DeFi wallet, you’re ready to begin buying and swapping tokens and coins. Keep in mind that different tokens and coins have different goals, purposes, transaction (gas) fees, and other specificities you should familiarize yourself with before acquiring them.

Most DeFi protocols are built on the Ethereum blockchain, so starting your exploration into DeFi with Ether or ERC-20 tokens is a wise place to begin so you can transact on the most popular DeFi protocols. The larger the community, the more access users have to learn from and trade ideas and strategies with peers, along with coins and tokens.

Another thing to keep in mind is many beginner users don’t think about factoring in gas fees when swapping coins or tokens, which is different from blockchain to blockchain. If a user is only transferring a small amount, they’ll end up panicking when they aren’t holding enough of a coin or token to pay the gas fee. Other times, beginners are shocked that the transaction took such a hefty gas fee. So, familiarize yourself with a coin or token and its fees before you end up out of luck and out of coins or tokens.

DeFi isn’t just about securing a loan or buying and selling cryptocurrencies. It’s more than that. Investors can, of course, lend and trade crypto, but they can also stake their cryptocurrencies and tokens for a reward. You may also choose to participate in yield farming, where you’ll earn interest by loaning some of your crypto towards meeting another user’s loan request. Another widespread use of DeFi protocols is joining liquidity pools that net you gains when trades are made in your liquidity pool. And that’s just the tip of the DeFi iceberg.

DeFi is an ever-evolving aspect of blockchain technology, and while in its infancy, relatively speaking, DeFi has a plethora of remarkable protocols in which users can choose to participate.

The most common way for users to interact with and participate in DeFi protocols is to visit the protocol’s website or application, allow it to connect to their wallet, then follow the instructions to begin using the DeFi protocol for whatever its purpose is. This might be yield farming, trading digital assets like coins, tokens, and NFTs, participating in a liquidity pool, or something else.

While still a relatively new technology, DeFi has many projects you may already be familiar with. The following short list of top DeFi projects is intended to serve as an example of the types of projects users can invest in. Before jumping into investing in any DeFi projects, it’s essential to do your research.

DAI is an Ethereum-based stablecoin soft-pegged to the U.S. dollar collateralized by a collection of other cryptocurrencies. These cryptocurrencies are deposited into smart contract vaults when a new DAI is minted.

Uniswap, the top DEX with a DEX coin, is an automated market maker known for simplifying the trading of DeFi tokens by efficiently solving liquidity problems with automated solutions.

Users can invest in the gamification of the Metaverse via the native MANA token. Any users holding MANA tokens can create and vote on proposals to change the game and acquire in-game NFT land.