Home»Blog»Cryptocurrency»DeFi (Decentralised Finance) in Crypto: Meaning, Types of DeFi Tokens and How to Buy Them
DeFi (Decentralised Finance) in Crypto: Meaning, Types of DeFi Tokens and How to Buy Them
28 October 2022
DeFi (Decentralised Finance)aims to integrate digital ledger technologies to phase out traditional banking services and boost efficiency of financial transactions.
A transaction involving fiat money goes through several processes from the sender to the receiver that are governed by centralised banking systems and financial institutions. These systems are often considered opaque, rigid and tightly-controlled by the governments. To deal with the inefficacies surrounding centralised finance systems, a gradual shift to a decentralised financial system or DeFi was evident.
Read on to know what is DeFi in crypto, how DeFi works, its benefits and the types of DeFi tokens.
What Is DeFi in Crypto?
A centralised monetary structure operates under the guidance of a central bank (RBI in India). Central banks control the demand and supply of money through bills and policies that pertain to the current economic condition. The crypto economy, however, lacks a centralised structure and works solely on confirming transactions in a blockchain.
The DeFinetwork is inclusive of financial products and services that are accessible to everyone on its blockchain. Unlike transactions with fiat money, the DeFi network operates without any central authority.
The booming cryptocurrency economy has enabled users to lend, borrow and invest funds by using a decentralised finance system. Like normal currency, you can earn interests and perform long-term/short-term investments on a DeFi blockchain.
Experts believe that the primary reason crypto investors choose the DeFi network is the ease of access and usage. DeFi networks remain open 24*7 and are more transparent than centralised systems. Bitcoin was the first cryptocurrency built on DeFi, allowing absolute control over BTC tokens.
Who Created DeFi Cryptocurrency?
Intending to create an online network of financial elements operating via blockchain, some Ethereum developers coined the term in August 2018 on a Telegram chat. An abbreviated version for Decentralised finance, developers who coined the term aimed to develop an open-source network that didn’t require a third party for financial transactions.
Some developers involved in coining this term include entrepreneurs like Inje Yeo from Set Protocol, Blake Henderson of 0x and Brendon Forster of Dharma. However, it is crucial to note that the concept of decentralised finance began with Satoshi Nakamoto, the mystery person who created Bitcoin.
How Does DeFi Work?
Unlike normal bank transactions, decentralised finance mechanisms eliminate barriers to entry for financial transactions. Users need to follow certain conditions to execute financial transactions. DeFi crypto acts as a lending network for peer-to-peer lending/borrowing within a specified network.
Certain elements that determine the functioning and usability of DeFi are:
Settlement layer: It forms the basic foundational layer of the DeFi blockchain and the underlying native assets. The settlement layer lays down certain basic security protocols and regulations for users to follow. Ethereum, for example, is a network on the blockchain with ether as its native currency.
Asset layer: Every blockchain has its own set of tokens and digital assets, which forms this layer.
Protocol layer: This layer serves as the principal protocol or guideline for all forms of smart contracts.
Application layer: Consumers access the blockchain via this layer. It acts as the bridge between blockchain and users and has its own user interface.
Aggregation layer: All dApps and protocols running in the system are connected by aggregators. These aggregators are essential organs that make the basic foundation for borrowing, lending and other financial services.
However, experts believe that decentralisation of the blockchain network poses the maximum threats and is subject to scrutiny. Since developers cannot unilaterally make a decision, they need to depend on consensus.
Although some decentralised applications find it difficult to function at their early developmental stage, the shift towards decentralisation is ongoing and steady.
Unlike conventional fiat-based financial systems, DeFi offers a high level of transparency, sector and growth opportunities. DeFi’s gradual shift towards a standardised economic system has enabled crypto enthusiasts and financial analysts to understand its aspects. Some benefits of adopting DeFi are as below:
Degree of programmability: The emergence of new financial instruments and digital assets has enabled the creation of programmable contracts. These contracts are digital signatures which allow automatic execution.
Higher degree of inclusivity and financial freedom: Crypto users need a digital wallet to access the DeFi system. Moving and trading assets on the DeFi system is easier than dealing with fiat money. Plus, users are exempted from paying conventional bank fees and transaction charges.
Transparency in financial transactions: Unlike the traditional financial structure, the functioning of the underlying blockchain in the DeFi network works in real-time. Thus, users of cryptocurrencies can access their accounts instantaneously. Plus, all transactions are confirmed through several layers of verification, thereby lessening the chances of fraudulent activities.
Asset custody and tamper-proof network: Most DeFi networks work on non-custodial crypto wallets and smart contract-based escrow that helps users retain their financial information. Moreover, despite DeFi protocols being open sourceapplications, they are tamper-proof and auditable because of their typical blockchain architecture.
Interoperability: DeFi protocols are individual packets of compostable software stacks that construct the crypto framework. For example, developers and users using Ethereum can rely on the existing protocols for customising their interface and integrating third-party applications.
What is DeFi Token?
Coins and tokens preserve the intrinsic value of a unit during a financial transaction. It is the digital version of fiat money that stores value and is a medium of exchange. However, unlike fiat money, theDeFi blockchaindoes not always transfer value in a financial sense. They can store and transfer passwords and other sensitive information between resources.
DeFi tokens are built on their respective native blockchains and are used to transfer value, not necessarily in the physical sense. The extent of the DeFi network is limited only by its usability, and with the introduction of Non-fungible tokens, users can store, buy or sell works of art.
With a market capitalisation of over $50 billion, the best DeFi coins are increasingly gaining importance. Some popular DeFi tokens that demand mention include DeFi Coin, Lucky Block, Decentraland, Cosmos, SushiSwap, etc.
What are the Types of DeFi Tokens?
DeFi tokens may come in various forms depending on their usability and ease of access. Experts believe the DeFi network is trusted and open to many programmable financial services. Some basic types of DeFi tokens include:
Stablecoins: They are essential instruments that maintain a constant value concerning another asset like USD or other fiat currency types. They can either be decentralised (non-custodial) or centralised (custodial) and can be incorporated into the DeFi network through consensus.
Exchanges: Sometimes, one asset can be represented in terms of another asset. DeFi exchanges utilise a decentralised order book to match orders at set prices. Thus, they avoid custodial responsibility of user assets.
Credit: Sometimes DeFi crypto creates time-bound interests bearing instruments that allow holders to earn interest on maturity.
Derivatives: Like fiat assets, DeFi networks also allow dealing with synthetic financial instruments like derivatives. These underlying sets of assets include futures and options and are referenced on the future maturity date.
Insurance: Specific tools in the DeFi network can provide protection against risks. Normally, it implies withdrawing a large pay-out of a covered asset by paying a small premium.
Asset management: Various factors like risk preferences, time horizons and diversification can influence an asset’s value. DeFi crypto coins consider all such assets that mature over time depending on market volatility.
How to Buy DeFi?
Anyone can purchase, store or sell DeFi units by purchasing them in the form of another cryptocurrency. Before performing the purchase of DeFi units, you must have a self-custody crypto wallet. Following are the steps involved in owning DeFi units:
Step 1: Download a crypto wallet available on a mobile application or browser extension.
Step 2: Set up your crypto wallet account by entering your personal information and logging in with a username. The username represents your presence in the DeFi network, and users can send or receive crypto units through this login information.
Step 3: Crypto wallets can be secured with a combination of words, also known as the recovery phrase. Remember that this phrase stores your account information and crypto units and should be dealt with carelessly. You can also use the cloud backup option on your crypto wallet to preserve your information.
Step 4: Educate yourself on the available plans for purchasing ETH. It would help if you consider the network availability, complexity of transactions and the modus operandi of transactions.
Step 5: With a valid crypto wallet/account, you can purchase your desired number of ETH. You can acquire your desired level of ETH via mobile application or the browser extension.
Step 6: You can use your purchased ETH to purchase DeFi tokens. Use your mobile application or browser to ‘trade’ your ETH for ERC-20 certified tokens. On payment of transaction fees, your purchase will get completed.
What is the Price Prediction for DeFi Coins?
A striking characteristic of any crypto element is its ability to fluctuate in response to external or internal shocks. Their bullish or bearish per unit price movement makes dealing with these sensitive assets interesting. DeFi coins have experienced random price movements since their beginning.
The DeFi Swap ecosystem works on a BEP-20 platform that can enable users to swap, stake and yield tokens. Presently, the per unit value of a DeFi coin is hovering around the $0.09 mark, and experts believe there is a possibility of a revaluation.
DeFi crypto price prediction involving three consecutive years has been discussed below:
End of 2022: You can expect DeFi coin valuation at around $0.65 towards the end of 2022, owing to its higher demand for additional services like swapping and staking.
End of 2023: The upward rising growth trend of DeFi can grow even further. This may lead to financial investors swapping fiat money assets for DeFi coins. Towards the end of 2023, DeFi coins are expected to reach a value of around $0.95.
End of 2025: The probable expansion of DeFi Coin and Swap services is likely to generate more yields. You can expect DeFi prices to exceed a dollar (roughly $1.40) by the end of 2025.
What are the Risks Associated with DeFi for Investors?
Unlike traditional financial instruments, you can store and handle DeFi cryptocurrency in digital assets or Stablecoins. Protocol developers manage their functioning and grant voting rights to users. However, despite the advantages of using the best DeFi cryptos, there are certain limitations that its usage poses. They have been discussed below:
Resource utilisation: The scalability and transaction fees for DeFi coins are considerably large. Moreover, like most crypto networks, DeFi coins require intense resource utilisation in the form of energy or human intervention.
Latent centralisation: Apparently, DeFi coins are free from decentralised financial holdings. However, experts believe that governance rights of individual players may cause an incomplete redistribution of power.
Return potential: Despite their popularity, DeFi coins have not yet reached the income-generating capacity that initiated their usage. The use of immature technology for managing high-value assets reveals poor design choices. Additionally, short-term returns can distract user expectations and slow down large-scale adoption.
Potential for fraudulent activities: Due to the lack of proper consensus and the absence of regulatory bodies, DeFi coins are prone to fraudulent activities. Additionally, its limited functionality and enforcement challenge further increase the probability of such instances.
The crypto world is a land of opportunities which is diverse enough in terms of scalability and inclusivity. The DeFi crypto network provides greater stakeholder control, increased standardisation and interoperability. However, dealing with such fluctuating financial instruments is risky, so one should always consider doing adequate research before investing.
FAQs on DeFi
Q1. What are the principal building blocks of the DeFi cryptocurrency?
Ans. The DeFi network comprises several elements, including blockchains, digital assets, wallets, smart contracts, Dapps, decentralised autonomous organisations and Stablecoins, etc.
Q2. How are DeFi coins or tokens different from traditional financial instruments?
Ans: Unlike traditional financial assets, DeFi instruments are held in non-custodial wallets. They are open-source codes that allow the public ledger to verify protocols and financial activities.
Q3. How does the partially decentralised governance work for the DeFi network?
Ans. The partially decentralised governance of the DeFi network allows signers to vote on crucial elements. Token holders can use this governance to execute votes directly. The centralised governance of developers allows them to make significant changes to the ledger and confirm transactions.
Q4. What are DeFi products?
Ans. Decentralised Finance products are a collective term used for digital assets that are accessible to anyone who owns Ethereum and has an internet connection.
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Disclaimer: Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions.
Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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