Many newcomers to the crypto industry often feel perplexed and overwhelmed by the complexity of investment instruments that differ from what many are used to in tradfi. One of the reasons why everything seems novel and unique is that the industry is still maturing. Some concepts like staking turn out great, while others, such as NFTs, fail miserably.
DeFi is a new word to millions of users across the globe. The biggest chunk of the international audience for this sector is in North America with Europe trailing behind and Asia expanding at a steady pace. Understanding the impact of this emerging industry on the global monetary system, economy, and society is hugely important for contemporary investors.
Centralized systems have their advantages. With the right management, they can improve consumer experience, provide the necessary level of protection from crime, and foster rapid economic growth. However, they are also vulnerable to exploitation if power-bearing institutions and individuals decide to use them to their advantage.
The story behind the first widely recognized cryptocurrency Bitcoin is all about the fight between good and evil represented by decentralization and centralization respectively. After the catastrophic 2008 financial crisis, the effects of which are still felt by everyone, an anonymous developer, or a group of developers, under the pseudonym Satoshi Nakamoto released the first iteration of the Bitcoin protocol.
Decentralized ledgers are not a novel invention that has never existed before. Systems like this have been experimented with in the early 1980s. However, only after the push from the failing centralized global economy, the concept turned into something more than a fun theoretical exercise. The expansion and continuous development of Bitcoin and Ethereum led to the formation of a completely new type of economy — a decentralized one.
The idea behind Bitcoin, Ethereum, and other blockchain networks is that recorded transactions remain as immutable data on a chain that can be publicly verified by anyone. Whenever one wallet sends money to another, this operation is recorded on a ledger. One can simply download the ledger and track the path of every single fraction of digital assets. At the same time, participants do not have to disclose information about themselves as wallet addresses are sufficient enough for the ledger to operate.
By creating this interconnected and simultaneously distributed data network, we are essentially removing the counter-party risk and making everything as transparent as possible. Decentralized finance applications leverage this feature to build mostly automated systems that can conduct operations in a trustless and permissionless environment enabled by the underlying blockchain.
Here are aspects of a DeFi system that may be present in a typical protocol:
Centralization has been the most natural process throughout our history. Vertical management structures are more efficient and can be incredibly robust during times of crisis. However, the effectiveness of such societal and economic architectures often depends on the ability of those who run them to perform well and deliver great results over long periods.
The economy is incredibly chaotic and the complexity has been increasing consistently before the industrial revolution. After that, there has been an explosion in the diversity of goods, services, commodities, and financial instruments designed to interact with them. Central authorities try to regulate this chaos using macroeconomic levers like interest rates, bond issuance, printing fiat, and more. However, corruption and greed as well as the ability of institutions and market participants to collude always lead to negative outcomes for the general public.
The main argument in favor of decentralization is the removal of overly influential institutions and individuals from the equation by creating a distributed monetary and economic system that does not need any intermediaries for any operations.
There are several key differences between CeFI and DeFi:
| Factor | Centralized Finance | Decentralized Finance |
| Governance | Regulated by the governmentEnforced by official bodiesControlled by institutions | Often governed by DAOsDoes not have a central authority |
| Accessibility | Relies on banks and institutionsCan be inaccessible in some regions | Accessible everywhere if there is internet |
| Transparency | Many operations are hidden behind closed doorsUsers do not have control over their managed funds | Ledgers are open to the publicInvestments are done via self-custody |
| Security | Institutions implement safety measures internallyThe government regulates the industry and may protect consumers | Security is based on the quality of smart contract designThe sector is unregulated leaving consumers exposed to scams and rug pulls |
| Liquidity | Provided by central institutionsSlippage is less of an issue | Provided by investors in exchange for rewardsSlippage is a big problem |
| Compliance and privacy | Requires institutions to follow KYC/AML practicesDeanonymizes financial operations | Allows for complete anonymityDoes not specifically require platforms to comply with regulations |
Whether you prefer decentralization is a question that has a different answer depending on who you ask. Libertarians and conservative individuals usually believe that having a small government that does not stick its nose everywhere is a good thing and that decentralization of the economy and monetary system is a net positive. People who rely on the government for protection and regulation often think that we don’t need decentralized systems at all.
Several prominent cryptocurrencies became hugely popular during the last decade, each for a specific reason. Bitcoin is a flagship coin that symbolizes a new era of digital finance. Ethereum is a haven for those who want to use crypto for a variety of purposes and create a more interconnected ecosystem. Monero is often used primarily for its complete privacy.
However, all digital assets in the ecosystem are used by people who desire the same thing: the ability to use their capital as freely, conveniently, and flexibly as in tradfi but with the added benefit of decentralization.
Many protocols provide essential services like data exchange between different chains (bridges), swapping assets (DEXes), lending and borrowing (Lending protocols like Compound), and more. The ecosystem is incredibly important for the long-term success of the crypto industry as a whole.
The level of user activity in the sector just like the total number of wallet addresses is growing at a steady pace. While some studies indicate that the number of users is dropping since 2022, others show that there is a significant uptick in cash flows and the general trend is positive. Regardless of what is actually happening in the ecosystem right now, it is a good idea to have some practice with these novel assets.
Everything starts with the creation of a wallet. You can follow a more complicated route by joining the network using applications publicly available on GitHub. However, the vast majority of people will be more than happy to simply download or purchase a crypto wallet.
The type of the wallet you need depends on your goals and requirements:
After creating and securing your wallet, you can go to any DeFi protocol and connect it to start investing or trading.
The variety of protocols in the sector is simply staggering. As of the time of writing, roughly 15,000 different pools were tracked by analytical platforms like De.Fi and DeFiLlama. The total number of protocols is in the hundreds and the diversity of practical applications is quite impressive.
Here are some of the options you may want to check out:
Other notable categories are real-world assets (RWA), derivatives, algo-stables, and cross-chain protocols. Note that the list above and all of the mentioned categories don’t even scratch the surface of the sector. It has so much more to offer.
With a rich selection of different protocols that you can invest in or use to better manage finances, finding the right tools for the job can be quite challenging. We want to give you several examples of interesting projects that may catch your attention:
These are the most prominent DeFi crypto examples that offer unique products and have large user bases. If you are interested in becoming an investor in the decentralized finance sector, you should check these protocols first. However, if you lack the experience to make an investment without any external help, it is a good idea to work with aggregators and specialized protocols like Yearn Finance or Rivo.xyz. The latter offers simplified investment opportunities for newcomers. For instance, their indices are designed to quickly introduce a beginner to the idea of yield farming.
Centralized systems are on their last leg. The 2008 financial crisis exposed the fragility of a global economy burdened by corruption and insatiable greed. Stopping such crises from happening is close to impossible when power is naturally aggregating in the hands of a few institutions and individuals. There is no substantial competition, punishment, or power distribution to talk about a stable economy.
Decentralization seems to be a great alternative for those who believe in a world where market participants can create a positive environment for rapid growth without any supervision aside from well-designed smart contracts.
There are several notable advantages to using decentralization as a way of transforming the global economy and monetary system:
Many other benefits like decentralized governance and flexible investment opportunities deserve a mention too.
While the benefits of using crypto and participating in the DeFi ecosystem are quite intriguing, some serious downsides have to be considered. Here are some of them:
In some cases, you won’t be able to counter these risks using conventional techniques like diversification, hedging, and doing your due diligence.
We are seeing many interesting developments in the world of finance. Large CeFi institutions like Blackrock are offering their clients Bitcoin ETFs while some governmental organizations allocate significant portions of their holdings to different cryptocurrencies. The push from the EU to roll out its plans to launch a CBDC that would act as a counterpart to the euro is also one of the hottest topics in the community.
Cryptocurrencies are being used for all sorts of purposes. Some are avoiding sanctions and international limitations while others are exploring novel investment tools promising huge returns.
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