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What is a DeFi Token?

what is a defi token

If you’ve taken an interest in blockchain and cryptocurrency, you will have seen or heard the word ‘DeFi’.

You may know it is an abbreviation of Decentralised Finance, or Decentralized Finance if you use American spelling.

But what does that mean? What is DeFi?

What’s It for?

Here are just a few examples of what decentralised finance is doing for us right now:

  • allowing us to send money anywhere around the world quickly and cheaply
  • allowing is to store money, in crypto wallets, and earn higher yields than with traditional banks
  • allowing peer-to-peer borrowing and lending
  • allowing us to trade cryptocurrencies at any time
  • allowing us to trade tokenised versions of investments like equities, funds, other financial assets, and non-fungible tokens (NFTs) 24 hours a day, seven days a week
  • expanding crowdsourcing

Decentralised Finance is a developing financial system built on secure distributed ledgers, similar to those used by cryptocurrencies.

The system essentially eliminates the control of banks and other financial institutions over money, monetary goods, and financial services.

It is inextricably linked to blockchain, the decentralised, immutable public ledger that underpins cryptocurrencies like Bitcoin. The idea is that no one entity has control over or can manipulate the transaction ledger.

The Ethereum network, the world’s second-largest cryptocurrency marketplace, is not only the foundation for the cryptocurrency Ether. It is also the basis for developing additional blockchain programmes, or applications, sometimes known as dApps. These programmes, or apps, can fulfil necessary financial services previously only available through institutions like banks, with Ether used to pay transaction fees.

Understanding DeFi

The starting point is to see how centralised finance differs from decentralised finance.

In the centralised finance system, we rely on banks. These are companies, with the ultimate goal of making a profit, which keep your money. There are then third parties that enable the flow of money between parties, usually charging for the service.

For example, let’s say you used your credit card to buy a loaf of bread. The charge is sent from the store to an acquiring bank, which then sends the card information to the credit card network.

The network cancels the charge and asks your bank for payment. Your bank approves the bill, transmits it to the network, and then delivers it to the store via the acquiring bank.

Merchants must be willing to pay for their ability to use credit and debit cards, so each entity in the chain receives payment for its services.

In a decentralised financial system, intermediaries are removed by allowing you, merchants, and companies to conduct transactions directly using emerging technology like blockchain.

Peer-to-peer financial networks with security protocols, connectivity, software, and hardware improvements are used to accomplish this.

You can lend, trade, and borrow from anywhere you have an internet connection using software that records and validates financial transactions in distributed financial databases. A distributed database can be accessed from numerous places; it collects and aggregates data from all users and validates it using a consensus method.

How Does it Work?

The most common way financial services are provided in a DeFi system is with cryptocurrency and smart contracts. This eliminates the need for intermediaries, such as guarantors.

Take, for example, lending. Users can lend their cryptocurrency and earn interest immediately in a decentralised system, rather than waiting. Borrowers can receive a loan instantly.

DeFi allows peer-to-peer trades without a broker, means you can save your cryptocurrency with potentially much higher interest rates than banks, and buy derivatives such as stock options and futures contracts.

These are just a few of the services available.

As mentioned earlier, some users employ dApps, which are primarily available on the Ethereum network, to facilitate peer-to-peer business transactions.

DeFi is open source, which means that its protocols and apps are theoretically available for users to examine and improve. As a result, users can create their own dApps by mixing and matching protocols to uncover unique combinations of opportunities.

Earning with DeFi

There are many ways people are trying to profit from decentralised finance. Perhaps most notable is using Ethereum-based lending apps to create passive income. Here users essentially lend their money out and earn interest on the loans.

Yield farming is another approach, although one considered a riskier practice and usually performed by more skilled traders. Here users search through DeFi tokens to find prospects for higher returns. It is, however, complicated and opaque.

#DYOR This is intended as an introductory guide to DeFi. As ever, I encourage you to do your own research and read multiple sources of information.

You can read more guest articles at brendanbeeken.com.

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