With Ethereum becoming more popular, you could be wondering if Ethereum is Defi.
Ethereum is part of Defi. Defi is short for decentralized finance. People usually mean decentralized services if they talk about Defi. For instance, decentralized exchanges or borrowing & lending platforms. Ethereum serves as a platform for Defi products and services.
What is Defi and how does it work?
Defi, short for decentralized finance, is a general term. At most basic levels, Bitcoin is Defi because you can buy and sell goods with Bitcoins in a decentralized way. You could call “nearly” everything in the crypto space Defi. The reason for that is that crypto focuses on financial instruments and decentralization.
Especially the Ethereum community started hyping this word because of various applications. Most people call systems Defi even though they are partly centralized. For instance, centralized organizations can be behind a project. They develop the protocol and decide how to improve it in the future.
The reason why Bitcoin or Ethereum is Defi because there is no central organization behind it. At smaller projects, the core developer teams have major control over the project.
Ethereum and the history of Defi
What are smart contracts?
A smart contract is code on the blockchain. In other words, a computer program. Smart contracts are permanent and immutable. Also, everybody could publish a smart contract on the Ethereum blockchain.
You can think of it as a Windows program. Google Chrome is an application for Windows. If we translate that to crypto, Ethereum is Windows. Google Chrome would be a smart contract on the Ethereum blockchain.
So, why did developers choose Ethereum and not Bitcoin?
Because Bitcoin doesn’t support smart contracts. Developers went to the next biggest project, Ethereum. Here is a list of things developers already built with smart contracts:
- Governance tokens: When you own this token, you have the power to vote for proposals to change the platform.
- DEXs (Decentralized exchanges) to trade tokens: These are exchanges that are controlled by nobody.
- Decentralized lending & borrowing platforms
All projects above are Defi products. Most developers went to Ethereum to build their applications on it. That’s the reason why most people associate Defi with Etherum today.
What is a decentralized trading platform?
A decentralized trading platform is a service where you can trade funds decentralized. In Ethereums instance, you can trade all Ethereum tokens on a DEX like Uniswap or Balancer.
Centralized vs. Decentralized trading platform
Here are problems that occur with centralized trading platforms.
- You give up your control over your coins
- You have to trust the service that everything goes well
- The service can lock your account
Decentralized trading platforms solve all the problems.
- You have full control over your tokens all the time
- You can see what is written in the smart contract
- You know what will happen with your coins if you perform an action
- There is nobody who can freeze your funds
These services have other risks, for instance, smart contract bugs. You could lose all your money if the smart contract has a crucial bug.
Other Defi products – Lending & Borrowing
You can build any financial instrument with smart contracts. Developers not only build decentralized exchanges, but they also built lending & borrowing platforms. They have similar advantages if we compare it with centralized units:
- No censorship
- Operates globally
- No third-party trust required
Okay, but the mentioned services above didn’t create the hype behind Defi. Developers had a great idea to have an incentive for users to use the platforms. They introduced tokens for the platforms. These tokens are usually governance tokens. So, a governance token represents voting power for changing things on the platforms.
These governance tokens are distributed to users who use the Defi services. For instance, when you borrow or lend tokens, you get extra governance tokens. It’s an extra reward for using the service.
You can, later on, decide if you want to sell this token or you want to hold it to take part in future voting requests. This is the reason why Defi is so popular. People farm these tokens and earn sometimes 20%+ / year per platform.
Interested in learning about all the different platforms and what benefits they have? Consider using my “21+ coin specifications” post. It’s worth 5+ hours worth of research. You can also use messari.io to get further project information.
What is yield farming?
Yield farming is the process of farming as many governance tokens as possible. You put your tokens through many services. So, you connect the services like a chain to farm as many different governance tokens as possible. This gives you the highest returns.
This carries a lot of risks. People should be aware that they can be liquidated and risk losing everything. There are other risks I didn’t mention. For instance, impermanent loss. You should do your research before you start investing in one of the Defi projects.
Defi Scams and hypes
The extra governance tokens give you ways to ridiculous high returns. Most of the time, the high yield is at the beginning generated through the hype. The market will get to a point where the yields are rated more stable.
Also, the Defi space attracts scammers. Everybody in the world can deploy a token even if it has no value. They usually launch a clone of an existing platform/token. Afterward, they sell all the tokens at the beginning and leave the project as fast as possible. Be careful if you invest in a Defi project.
How do you detect fakes?
Go to coingecko.com, search the token, and copy the contract id. They have the official ids and based on that, you can find fake tokens that have the same name, but not the same id.
Also, be careful about hyped projects. Everybody will tell you to invest in project XYZ because it is so innovative, good, and so on. Most of the time, these people are right, but they only have a narrowed view.
What do I mean by that?
They believe so much in one project that they don’t even consider other projects as good or as worthy. Other projects can be as good or even better than that project you get promoted. Do your research about the project and decide on your own if you want to invest or not.
In the Ethereum Defi space where things are moving fast, hyped projects can be attractive. You see the price charts and they look ridiculous. Never get baited by prices.
The price of an asset is not equal to the value of an asset. Analyze the value and don’t get baited by the price.