Defi (Decentralized Finance) Smart Contracts: An introduction for beginners

Decentralized Finance Defi

The hottest topic in the world of cryptocurrency and blockchain technology has been Defi (Decentralized finance) for a minute. What are Defi smart contracts and are they worth the hype? The simple answer is yes. Data from defipulse.com reveals that the Defi industry has gone wild with over $49 billion (April 2021) locked up already. Just less than a year earlier the figure was still at $972.9 million (June 2020) Ignore Defi at your loss.

For a better understanding of Defi, we need to go back to what smart contracts are. No, they are not to be confused with legally binding contracts- you know, the kind your Attorney drafts. It has nothing to do with the judicial system. Smart contracts are programmed codes that are executed when some predefined conditions are met. It helps you transparently exchange anything of value without the need for a middle man. Say you want to purchase some digital assets from a stranger for $100, a whole lot of issues could arise all stemming from a lack of trust.

How do you determine who sends first? What if you send first and the stranger defaults? At the same time, the stranger is also thinking if he sends the digital assets first you might not pay the agreed $100. To solve these problems many use escrows which are individuals or companies that serve as middlemen that charge you for such basic service. They ensure both parties get what’s due. 

Smart contracts make it possible to carry out the same exchange without a need to trust a third party or anyone. Smart contracts are programmed to receive and redistribute digital assets. Ethereum blockchain is the biggest smart contract platform at the moment. 

What is Defi?

Smart contracts could be useful in different industries and this is what led to the invention of Defi smart contracts. Decentralized finance or Defi takes the components of traditional finance and replaces them with smart contracts leading to a wide range of benefits.

The Good

Building more complex financial systems using blockchain smart contracts enables you to participate in such financial activities as loans, collateralized debts, and fundraising outside of the traditional banking system. Indeed traditional banking system has failed us considering millions are still unbanked and are excluded from accessing such benefits like loans simply because they are poor. And don’t get us started about these greedy banks and exorbitant charges. Defi is righting many wrongs in the financial system today.

The beautiful

Let’s take an in-depth look at some of the benefits of Defi

– Taking out a loan: Borrowing money from the traditional banking system can be an arduous process with all kinds of embarrassing verification taking place. Discriminatory procedures and actions might also mean you end up being denied. Defi works differently. First, you get to keep your dignity and stay pseudo-anonymous meaning no one needs to know your name, your address, or collect your documents, etc. Neither does it deny you access because you have low credit scores and other discriminatory factors. So how does it work? Think of it like you’re getting a loan from a pawnbroker. The amount you will have access to depends on the worth of the article of value you’ve dropped as collateral so that such items can be sold in the event the borrower defaults. Similarly in Defi, you need to submit collateral (digital tokens) which is locked up in a smart contract called Collateralized Debt Position. Doing this will give you access to a wide range of financial services. Everything is controlled by the smart contracts without needing approval from anyone

– Supplying money to earn interest: Defi provides an easy way to do that. Lenders deposit money which is held in the smart contracts. Interest rates, loan duration, and other fine details are programmed in the smart contracts which automatically execute to send out your interests as agreed.

– Safety against inflation: Inflation is one of the many areas in which fiat currency has failed us. Many economically impoverished countries like Venezuela have suffered a continuous devaluation of their currencies. Holding assets in currencies like this would mean a continuous decrease in purchasing power. With the same amount, you can no longer purchase what you used to 19 years ago. But with Defi, you could preserve your purchasing power by holding assets in other currencies (for example USD pegged stable coins). As icing on the cake, you even make interest.

– Engage in financial activities outside your geographic location: Today many are denied access to financial instruments such as loans because they live in areas where these are not accessible. Defi has no geographic barriers of that nature. Anyone, anywhere in the world has access to financial services with just a few taps on their computer or smartphones.

The Bad

– Defi is just a buzzword. Decentralized Finance as practiced now is not truly Decentralized. It usually has a centralized company at its back that created the smart contract that powers the system. A more apt term for Defi is non-custodial finance which means you still hold the keys to your Crypto assets and are in charge of what happens to it.

– Smart contract bugs which could cause the codes to malfunction can cause people to lose their funds. Although insurance projects now exist that covers this scenario

– Defi is still too complex to use for average people requiring you to use tools like metamask wallets. Thankfully, our readers fully understand how to use a meta mask. Check out our tutorial here.

– Defi loans are over-collateralized. This means to access the loans, your deposits in the blockchain should be more than you’re taking out.

The future of Defi

We see an explosive growth potential for Defi. If it is to find further adoption, more Defi platforms will need to make the move from over- collateralized loans to under-collateralized loans. A loan reputation system that is recorded on the blockchain could be developed soon that regulates to what extent loans can be under-collateralized based on individual history of borrowing.

Defi Tools and platforms

The Defi space is beginning to fill up with a list of interesting projects. Several tools have been designed to help you properly navigate the Defi Universe. Here are a few:

  1. Defipulse.com: To see how much money is locked up in Defi
  2. Loanscan.io: helps you compare interest rates of different platforms so you easily pick the right deal for you.
  3. Compound.finance: Interested in earning interest on your Crypto holdings? This company is a good place to start (Other similar companies: Fulcrum, Idle Finance, DDEX, Aave, etc.)
  4. Tokensets.com: To manage your Crypto assets
  5. Defi insurance startups like Nexus Mutual, Etherisc, and CDx are good for space.

We are excited about the future of Defi smart contracts and you should be too. Keep in touch with other related matters in the Decentralized world by bookmarking this blog now. 

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