Finance is now decentralised and better!
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In the centralised world that we’ve been living in, we earn and spend in the currency that’s issued by the central bank and government. They have full control over our money. They won’t say it out loud but the they do. They can print money whenever they want, they can deny your loan for your business, they can charge you a high interest rate on your loans and they can block all your bank accounts if they feel like. Ahem ahem… Canada.
All you Cryptalks readers already know most of these pointers through the previous write ups but I felt the need to reiterate the negatives of a centralised currency for this post. So far, we’ve spoken about how to spend using a cryptocurrency. What you do not know is how to multiply the cryptocurrencies you have using decentralised tools!
In today’s post, we’re going to talk about DeFi - Decentralised Finance, why it’s better than traditional finance and how you can use it to your advantage. But first, as always let’s briefly discuss how it works. DeFi uses of 3 elements and they are the common ones: cryptography, blockchain and smart contracts. By making use of them, creators and inventors in the space have been able to make alternatives for existing finance products like exchanges, banks, insurance and even margin trading.
Before we talk about the projects built in these 4 sectors in the cryptosphere, let’s talk about one integral product that allows mainstream adoption and makes the DeFi projects attractive - Stable coins. Think of stable coins as the bridge that connects the two worlds (centralised and decentralised). They are pegged to real world FIAT currencies. USDC, USDT and DAI are examples of stable coins. You can understand the difference between these stable coins here. Why are they important? Let’s understand with the use of an example.
Let’s say Jai trades cryptocurrencies and in order to do that, he uses a centralised exchange like CoinDCX. Now Jai had bought 1 ETH for 1000 dollars last month, the price is now 2000 dollars and because Jai has paper hands, he decides to sell his ETH. He sells his ETH for 2000 dollars and pays a hefty fee to the centralised exchange (CEX) to do so. He also pays 30% Modi tax on the financial gains he made. He then withdraws these funds to his bank account for which he pays some more fees. 🙂 Fast forward to next week when ETH is trading at 1500 dollars, Jai buys it where he pays a fee to CoinDCX again. The cycle goes on. Essentially, Jai is making multiple transactions, paying hella fees, he’s giving centralised Modi a piece of his decentralised currency profit and it is time consuming!
Now Jai isn’t a Cryptalks reader, but if he was, here’s what would happen. He’d trade his ETH worth 2000 dollars for USDC. Hold on to the profits and buy again at 1500 dollars using his stable coin. The advantages? 1 transaction, extremely low fees and a maximum of 5 minutes for the transaction to go through. All this is possible through a Decentralised Exchange (DEX) which we’ll talk about now.
A decentralised exchange is a currency exchange platform where you can trade one cryptocurrency for another. They operate on smart contracts which means they work completely on code which completely eliminates the chance of human error. All transactions are recorded on the blockchain making them transparent. Now because these exchanges are decentralised and run on code, no government can ban them. Also, the fees are coded in the Smart contract too and since they are immutable, they won’t rise to exorbitant amounts. Ever. Oh and did I mention that users get access to thousands of cryptocurrencies on a DEX as compared to about a 100 on a CEX?
So you’re paying lower fees (less than 0.5%), performing fewer transactions, waiting for a shorter period of time and the process is completely transparent and decentralised. What’s not to like?! UniSwap and PancakeSwap are 2 of the most widely used DEXes and they have billions of dollars worth of funds locked in them!
The second problem that DeFi solves better is lending and borrowing. Projects like Aave and Compound allow users to lend and borrow money. I can lend a cryptocurrency to you. You pay a certain amount of interest on the loan, most of which I get and a small portion goes to the protocol. Here’s the caveat though, these loans are over-collateralised. So if you want to borrow 100 tokens of X cryptocurrency, you have to keep 120 as collateral.
You’re probably wondering why would any sane person want to borrow less than he’s giving as collateral. That’s because your mind is still in the centralised world. Let’s assume that you have 5 ETH which is worth 5000 USDC and you really believe in the long term value of the token. However, right now you need 4000 USDC because you see an opportunity to make some money. You can give the 5 ETH as collateral, borrow 4000 USDC and make some more USDC. When the time for paying back the loan arrives, you can pay back 4000 USDC + interest, get your ETH back + keep the money you made. In case you fail to pay back the loan, I get to keep your 5 ETH and you can keep the 4000 USDC you borrowed. The whole process is taken care of by smart contracts.
Moving on to insurance. In the world of DeFi, the entire insurance company can be just code. All they need to write is something as simple as this; if Karan the farmer has deposited 2 ETH and if the temperature is over 40 degrees for 7 days or more during the year, then give him 10 ETH as compensation for the crops he lost.
You’re probably wondering 2 things right now, where does the 10 ETH come from and how on Earth does the Smart contract know the temperature? Well, the money comes from the investors who created the protocol and the smart contract knows what the temperature is through the use of Oracles; they are sources that provide real world data to any blockchain that requests it.
The last type of DeFi projects that I’d like to talk about are margin trading protocols. For those of y’all who don’t know what margin trading is, it is basically taking a loan and trading in the markets with those funds.
Traditionally, in order to be able to trade with margin you need to complete certain KYC steps and have a 6 digit account balance at the very least. You also pay hefty interest rates on that go as high as 20% on the profits you make. With decentralised protocols, you can borrow these funds anonymously. You don’t need to maintain a threshold balance and you avoid paying high interest rates on the funds you borrowed. You can check some of these protocols here.
Hopefully after reading this post you can see the value that DeFi brings to the world of finance. I’d suggest you get your hands dirty by trying some of these protocols because the best way to learn is to have some skin in the game. Feel free to reach out to me incase you get stuck or you need some help with the protocol you want to try.
Happy reading y’all, I’ll see you on the next one. Don’t forget to drop a like if y’all learnt something valuable today. It takes less than a minute and it helps the substack algorithm to show this newsletter to more people! It also low-key (high-key) makes me feel good when y’all show some love. 😜
DISCLAIMER: This post is NFA. DYOR!
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