DeFi

Decentralised Finance or DeFi for short, is a component of blockchain technology that focuses on combining the core tenets of blockchain and the traditional finance (TradFi) industry. This general term applies to several practical use cases and platforms within cryptocurrency. DeFi aims to build a better financial system that is permissionless, trustless, sovereign and secure. Ultimately the goal of DeFi would create a system that cuts out the middlemen or gatekeepers who currently have control of who can participate in monetary transactions. This democratisation would allow for more participation across the global ecosystem. The following terms below explain the different aspects of DeFi.

Lending/Borrowing - This vital part of DeFi allows cryptocurrency users to either lend their tokens in exchange for interest or borrow tokens from a protocol or counterparty with fast settlement times. Due to the differences inherent to blockchain technology, these systems differ from lending and borrowing in traditional finance. For example, the borrower must provide collateral for loans generated on the platform. This ensures the system can stay solvent and that users have the incentive to pay back their loans. This avoids the need for “know your customer” (KYC) on some platforms, which is required for all regulated banks in the traditional finance world. Additionally, these transactions can take place much quicker within DeFi and generally take only a few minutes to complete, which benefits lenders and borrowers alike.

Yielding Farming - Similar to staking, yield farming (aka farming) allows users to earn rewards for depositing assets into liquidity pools in exchange for token rewards. The main distinction between the two is that farming requires at least two different tokens to be added to the pool simultaneously. While this method of earning interest can be more lucrative, it can also be riskier due to issues such as impermanent loss. This means that when prices are volatile the change in token prices can cause an individual's share of the liquidity pool to be less valuable than when it was deposited. Although the price can increase back to the original price if the market moves to the price the tokens were deposited at, thus “impermanent” loss.

Derivatives - This type of cryptocurrency asset is fundamentally the tokenized version of derivatives from traditional finance. Both DeFi and TradFi derivatives are financial contracts that are used by buyers and sellers to trade the underlying asset instead of the asset itself. These contracts are generally satisfied once a particular set of requirements are met, such as a certain length of time or the price of the token. This asset class can be divided into two major subcategories, which are “futures contracts” and “options contracts.”

Futures contracts - These assets create an agreement that represents an individual’s right to sell or buy a token in the future at a specific predetermined price point. For example, to buy BTC for $30,000 in 5 months, regardless of the current price at that future date. The main difference between futures and options is that a future is legally binding meaning the investor must execute the agreed terms at the end of the period whereas options are not obligatory.

Insurances - Similar to how traditional insurance operates, crypto insurance protects an individual or group against potential cryptocurrency losses associated with a variety of negative impact factors, such as theft, data breaches, or human error. Policies can be obtained via crypto insurance companies and can vary in price depending on the value of the funds being secured.