Welcome to the world of DeFi, which stands for Decentralized Finance. Don’t worry if this idea is unfamiliar to you; I’m gonna break it down. I’ll explain what DeFi is, how it functions, and why it’s significant. To further clarify, I will also provide some simple examples. You’ll understand what DeFi is all about and why so many people are discussing it at the end.
Traditional finance, i.e centralized finance relies on banks and institutions to manage money, while decentralized finance (DeFi) uses blockchain technology to allow people to manage and trade their assets directly, without intermediaries. So no one can check how much you’ve got in your account or track you.
Okay, but you may ask, what are these assets that you can trade in Defi? Let’s see.
Cryptocurrencies like Bitcoin and Ethereum are common examples of assets in DeFi. To put it simply, even the cash you have in your wallet is an asset. So, in the world of DeFi, your crypto currency becomes your asset and you can trade or buy things with it.
Apart from these crypto currencies, there are other “tokens” that represent other assets or financial products. And that include stablecoins, lending and borrowing tokens, and blockchain-tokenized assets like equities or real estate.
And again, what exactly are these tokens, what tokenized assets, how can you trade equities or real estate with these tokens? Lets learn.
What are tokens in Cryptocurrency?
Tokens are digital representations of real-world items like cash or coupons that are kept on a safe internet network known as a blockchain.
These tokens are produced and controlled on a secure blockchain which is a secure digital ledger. These are creates using smart contracts that manage the rules of how a token should be handled and used.
Now let’s see how many types of tokens are there.
- Cryptocurrency Tokens
Digital money that you can use for transactions online are called cryptocurrency tokens. Bitcoin is a well know example of this. Just like how a dollar note is a token for fiat currency with monetary value, bitcoin is a token of cryptocurrency with monetary value.
- Utility Tokens
Utility tokens are digital coins that you can use on a certain online site instead of traditional money to get their services or benefits. Binance Coin is a great example for this. It’s used to get lower trade fees on the Binance cryptocurrency exchange platform.
Due to the flexibility of DeFi and cryptocurrencies, even you can create your own token for your services of products and provide the same. Watch this place for more on that later.
- Security Tokens
Security tokens are digital versions of common investments like stocks, real estate and bonds that show you own real-world assets. They you the same rights, like the chance to get dividends, share in company profits, or vote on important business choices.
If so, then you may ask why these are not called Equity or stock tokens. Here’s why.
The word “security token” is more general and better describes the wide range of rights and assets that these tokens can stand for. Stocks or equity tokens are a type of security token, but security tokens can be a lot more than that.
So, tokens like Equity, Debt, Real Estate, Revenue Sharing, Fund etc all come under security tokens. So, a security token is a digital bond with digital contract terms that apply to real world assets.
- Stablecoins:
Like the name suggests, Stablecoins are cryptocurrency that’s designed to have a stable value. So, these are pegged to real world currency or commodities like dollar or gold.
To put it more simply, cryptocurrency is pure digital money while Stablecoin is a digital representation of real world money or commodity. Eg: Dollar, rupee, gold, crude oil, etc.
- Governance Tokens:
One kind of digital token that allows its holders to have a say in how a decentralized platform or project is run is called a governance token. The community can have a role in the platform’s growth and management by using them to vote on proposals, revisions, or improvements.
How De-Fi works – with an example
Suppose, if there’s an organization called Zeta with it’s own Zeta token, and these can be bought by people of the organization on a platform managed by Zeta.
Those who buy one Zeta coin will have the ability to vote on any proposal Zeta makes. So, if Zeta proposes to either go on a company wide vacation or cash bonus on Christmas, then those with zeta coins can vote as they wish to decide on what to do. The more zeta coins you have, the more control you’ll have.
And in case if an employee is departing from an organization, then can exchange their zeta coins for real cash and leave. Simple!
Similar to these tokens there are other types of tokens. Let’s see what they are.
Non-Fungible Tokens – These are tokens for digital art, content etc.
Reward Tokens – Tokens given as rewards for participation or achievements within a platform or ecosystem.
Access tokens – Tokens that provide access to a specific service or feature within a platform.
Hybrid Tokens – Tokens that combine features of multiple token types, such as utility and security aspects.
And so many other types anyone can think of. Your imagination is the limit here.
But the bottom line is, tokens enable people to make a digital bond, currency or a representation to carryout various tasks and duties.
Okay, now you know what tokens are and how they work. But what’s their role in Decentralized Finance? Let’s learn
Role of Tokens in Decentralized Finance (DE-Fi)
There are many financial services and apps built on blockchain technology that are part of the DeFi (Decentralised Finance) community.
The idea behind DeFi is to copy and improve existing financial systems by offering decentralized options for things like investing, selling, lending, and borrowing.
In this ecosystem, different decentralized apps (dApps) and protocols (set of rules and standards) run on their own with the help of smart contracts (Self-executing contracts with the terms directly written into code).
This lets users do financial transactions and use financial services without banks or brokers getting in the way.
How do tokens and smart contracts work in real world?
Lets understand how these Tokens and Smart contracts work in real world in a real estate sale setting.
Let’s say you are selling a house. Firstly, the house is tokenized, meaning its ownership is represented by a digital token on a blockchain. For example, a token called HOUSE-TOKEN represents ownership of your property.
You as an owner will make this happen by proving your credentials and ownership in real world over blockchain with services that help with Ownership Verification, Smart Contract Control, Tokenization, Fraud Prevention etc.
How to sell a house with DeFi
On the blockchain, smart contracts are used to create and manage a token. The rules and features of the tokens, including their issuance, transfer, and interactions, are outlined in these contracts.
Once a token is created, it has to get verified and audited to ensure there are no vulnerabilities and loopholes. And then it’s integrated within the service that enables your sale. Those services are decentralized applications called dApps.
One tokenization is complete, you’ll deposit your token, and the buyer will deposit their cryptocurrency in the tokenization platform. And with the help of Smart Contract Escrows, Legal Agreements, and Payment Verification, the final sale is conducted and token and currency transfer takes place.
Completely digital with no banks and registrars in middle while being legal.
Is DeFi sale better than Traditional sale?
While this process may seem similar, they differ primarily through the use of blockchain technology.
Which means, the proof of this transaction is available globally without geographical limitations. So, no single entity can later alter the terms or sale validity for their sake.
This is much more transparent, immutable, safe, and cuts down various fees for intermediaries, legal services, and administrative tasks, which can add to the overall cost of the transaction.
| Aspect | Smart Contract Sale | Traditional Contract Sale |
| Platform | Blockchain (e.g., Ethereum) | Conventional legal and banking system |
| Transaction Medium | Cryptocurrency or digital tokens | Fiat currency (e.g., dollars) |
| Role of Intermediaries | None (self-executing) | Bank, registrar, notary public |
| Contract Execution | Automated through code in the smart contract | Manual, involving signing and verification |
| Verification | Automated (smart contract code) | Manual (through intermediaries) |
| Transparency | High (public ledger on the blockchain) | Varies (depends on intermediaries’ processes) |
| Security | High (code-enforced terms, blockchain immutability) | Medium to high (reliant on intermediaries’ integrity) |
| Cost | Lower (fewer intermediaries) | Higher (fees for bank, registrar, legal services) |
| Time to Complete | Typically faster (depends on blockchain speed) | Usually longer (processing and paperwork involved) |
| Dispute Resolution | Limited (code enforces terms strictly) | Provided by intermediaries (e.g., legal system) |
Now this brings us to our next question.
Why Does DeFi Matter?
DeFi is not merely another trend in technology. It represents a paradigm shift that has the ability to liberalize the financial sector and revolutionize the way in which we handle our financial matters.
And for that to happen, we need to look at Decentralized Finance is not an alternative to Centralized Finance, but an update to it. Enabling you, me and everyone to carryout our lives in a much more transparent, safe and efficient way.
Here’s why DeFi is important.
- Financial Inclusion: There is a considerable section of the world’s population that doesn’t have a good banking system, and so traditional finance frequently excludes them from its services.
DeFi eliminates these restrictions, making financial services available to anybody with internet. This has the potential to revolutionize the lives of people who live in areas with restricted or constrained banking system.
- Transparency & Security: DeFi uses the protection and openness that come with blockchain technology. A public ledger keeps track of all activities, making them easy to check and lowering the chance of fraud or manipulation. This helps people accept and believe in the financial system.
Everyone of us heard about illegal activities of ownership hijacking, contract frauds, duping and double selling of assets. All of these are prevented with DeFi.
- Greater Control: In the conventional method, you entrust your financial resources to financial institutions and brokers. But DeFi gives you control of the situation again.
Maintaining full control over your assets and the manner in which they are utilized is possible with the help of smart contracts that manage transactions.
- Innovation & Efficiency: DeFi stands on top of innovation. There is a continuous development of new financial products and services, which contributes to the creation of an environment that is both dynamic and competitive.
Another benefit of decentralized finance is that it streamlines financial operations by doing away with intermediaries, which results in increased efficiency and decreased costs.
Conclusion
And with this, we’re gonna conclude our lesson on what DeFi is and why it’s important. Here are a few frequently asked questions by people on Defi.
1. Is DeFi safe?
The blockchain technology, which is well-known for its security, is utilised by DeFi. On the other hand, decentralised finance is still in its early stages of development, and users should be wary of scams and exploitation. Before working with any DeFi platform or protocol, it is important to conduct extensive research.
2. How do I get started with DeFi?
- Set up a crypto wallet: This will store your cryptocurrencies and interact with DeFi applications.
- Fund your wallet: Purchase cryptocurrencies from an exchange and transfer them to your DeFi wallet.
- Choose a DeFi platform: Research reputable DeFi platforms that align with your financial goals (e.g., lending, borrowing, trading).
- Connect your wallet: Link your DeFi wallet to the chosen platform to interact with its functionalities.
3. What are the risks of DeFi?
- Market volatility: Cryptocurrency prices can fluctuate significantly, leading to potential losses.
- Smart contract bugs: Code vulnerabilities in DeFi protocols could expose your funds to theft.
- Rug pulls: Scammers may create fake DeFi projects and steal user funds.
4. Is DeFi legal?
The legality of DeFi varies depending on your jurisdiction. Regulations are still evolving, so stay informed about the legal landscape in your region.
5. What are the benefits of DeFi?
- Financial inclusion: DeFi offers financial services to anyone with an internet connection, regardless of location or banking access.
- Transparency & Security: Blockchain technology ensures transparency and security of transactions.
- Greater Control: You maintain complete control over your assets with DeFi, unlike traditional finance.
- Innovation: DeFi fosters innovation in financial products and services.
Remember: This FAQ section provides a general overview. Conduct your own research before making any financial decisions in the DeFi space.
Leave a Reply