In order to demystify DeFi, we need to get the grasp and explore the basics of traditional financial institutions.

We will focus on the influential players in the financial system -The Banks and their potential risks.

• Banks serve as a channel for payments, repositories for deposits, and providers of credit. The top 10 banks worldwide have a market capitalization exceeding $2 trillion.

• They facilitate the movement of money globally by offering essential value transfer services. However, banks are prone to human-related risks like mismanagement and corruption.

• Understanding these vulnerabilities is crucial as we delve deeper into the world of decentralized finance.

Now DeFi seeks to build a better financial landscape made possible by the evolution of the internet and blockchain technology, in three key areas:

1. Transaction & Validation system (Remittance)

2. Accessibility

3. Centralization & Transparency

TRANSACTION AND VALIDATION:

Sending money across borders through traditional banking systems involves delays, fees, and potential complications related to documentation and compliance. Let's use this for instance; a Relative in the US sends you $500 through the western union, there are basically three fees involved which are:

1. Exchange rate

2. Inbounds fee

3. Outbound fee

• It might take a while for the money to get to you depending on the working days, networks...

• But cryptocurrencies bring the concept of decentralization of finance enabling direct transfers with faster processing times, lower fees, and eliminating profit-heavy intermediaries.

• Cryptocurrency transfers can take 15 seconds to 5 minutes, depending on various factors, providing a more efficient alternative to traditional remittance methods.

ACCESSIBILITY:

If you're reading this article, you probably have a bank account and access to various financial services. However, many people are less fortunate and lack even basic access to a savings account.

• As of 2017, 1.7 billion people, mostly from developing countries, lack a bank account due to reasons like poverty and trust issues and some other certain factors.

• However, two-thirds of them had access to mobile phones, with an internet connection, hence DeFi Decentralized Applications can serve as a medium for the unbanked to get banked, providing access to financial products without traditional banks' lengthy verification processes.

• DeFi aims to offer borderless, censorship-free, and accessible financial products, making the on-boarding of financial services go smoothly.

CENTRALIZATION AND TRANSPARENCY

The traditional banking system, while considered safe for some reasons, has its flaws as the incident that happened in 2008 resulted in the fall of the Lehman brothers which lost over $639 billion in assets.

• In the US alone, over 500 bank failures have been recorded, revealing a centralization risk. The traditional banking system struggles with transparency whereby investors are unaware of financial institutions' activities.

• DeFi, unlike the traditional banking systems, operates differently. Built on public blockchains like Ethereum (an open source ecosystem), DeFi protocols are open-sourced for transparency. They often have decentralized governance to prevent individual bad decisions.

• The code is written in a way that treats all participants equally, preventing manipulations. But understanding the code is necessary to assess functionality. In practice, most users rely on factors like the developers' reputation and community approval, making DeFi dependent on decentralized peer-to-peer review. It`s strength lies in removing intermediaries and operating without censorship of centralized entities.

DECENTRALIZATION VERSUS CENTRALIZATION

• The current banking system faces major problems like oppositions, inaccessibility, and regulatory uncertainties. Not everyone has the privilege of being part of this system, leading to financial inequality.

• DeFi (Decentralized Finance) aims to eliminate barriers, making finance available to everyone without censorship. It offers opportunities across various financial sectors without restrictions based on factors like race, religion, age, nationality, or geography.

• This article will guide you through the concepts of decentralized finance, helping you leverage its features to address real-world issues.

LET’S DIVE FURTHER INTO DECENTRALIZED FINANCE (DEFI)

What is DEFI?

DeFi is a movement enabling users to access financial services such as borrowing, lending, and trading without relying on centralized entities. These services are offered through Decentralized Applications (Dapps), mostly deployed on the Ethereum platform.

• DeFi isn't just one thing; it's a mix of financial services mimicking traditional systems like banking and insurance. DeFi Dapps, also called money LEGOs, allows users to combine these services for their financial needs.

• Collateral is usually required and the total amount locked in these Decentralized Applications are known as Total Value Locked. The Total Value Locked at the start of 2019 measured around $275 million and reached a high of $1.2 billion in February 2020.

• As of April 2021, the Total Value Locked in Ethereum alone is an impressive $67 billion, indicating significant progress. This doesn't even include other blockchain networks like Binance, Solana, and more. Together, the Total Value Locked for all chains reaches $86 billion.

THE DEFI ECOSYSTEM:

The DeFi ecosystem is growing rapidly, so it is better to understand the grasp of DeFi before diving any further to what the ecosystem has to offer!

• These Decentralized Applications (DApps) aim to revolutionize traditional financial services by eliminating middlemen. Keep in mind that DeFi is still in an early and experimental stage, with projects evolving daily and with the right information you can benefit from what DeFi tends to provide.

HOW DECENTRALIZED IS DEFI?

Determining the decentralization of DeFi is not straightforward. But We can categorize it into three levels:

\>Centralized.

\>Semi-decentralized.

\>Completely decentralized.

• CENTRALIZED

Traits: Controlled by a single entity, uses centralized price feeds, determined interest rates, and provides liquidity centrally.

Examples: Salt, BlockFi, Nexo, Celsius.

• SEMI-DECENTRALIZED (Some traits, not all)

Traits: Not controlled by a single entity, decentralized price feeds, allows initiation of margin calls, provides margin liquidity without permission, decentralized interest rate determination, and platform development/updates.

Examples: Compound, MakerDAO, dYdX, bZx.

• COMPLETE DECENTRALIZED

Traits: Every part is decentralized.

Examples: Currently, no DeFi protocol is fully decentralized.

• Most DeFi Dapps fall into the semi-decentralized category. To delve deeper into the decentralization components.

• Check out Kyle kistner article Now that you get the idea, let’s explore key DeFi categories.

DEFI KEY CATEGORIES:

In this article we'll be exploring nine key DeFi categories.

1. STABLECOINS:

Cryptocurrency prices can change a lot up to 10% per day, so stablecoins like Tether (USDT) were created to peg their value to assets like the USD. However, using USDT requires trust in the reserves.

• Decentralized stablecoins aim to solve this trust issue by using over-collateralization, operating on decentralized ledgers, and having decentralized governance, allowing public conduct an official financial inspection (audits).

• Stablecoins, although not apps themselves, are crucial for making DeFi accessible to everyone by providing a stable value.

2. LENDING AND BORROWING:

Traditional finance requires or involves bank accounts, which 1.7 billion people lack. Borrowing involves hindrances like a good credit score and collateral which some individuals can barely afford.

• Decentralized lending removes these barriers, letting anyone use digital assets as collateral for loans. It also enables earning by contributing to lending pools. No bank account or credit check is needed with decentralized lending.

3. EXCHANGE:

To swap one cryptocurrency for another, people use centralized exchanges like Coinbase or Binance.

• However, these exchanges, acting as both intermediaries and custodians, risk users' assets in case of hacking. Decentralized exchanges address this by enabling crypto swaps without giving up custody.

• Users don't need to trust exchanges to remain firm since no funds are stored on them.

4. DERIVATIVES:

A derivative is a contract with a value linked to another asset like stocks, commodities, or currencies.

• Traders use derivatives to reduce risk in a trade, for instance, to protect against unexpected increases in prices.

• Traditional derivatives are traded on centralized platforms, but DeFi is introducing decentralized markets for derivatives.

5. FUND MANAGEMENT:

Fund management involves looking after assets and managing cash flow to generate investment returns. There are two main types of fund management:

Active Fund Management: Where a team makes decisions to beat a benchmark.

Passive Fund Management: Designed to mimic a benchmark.

• In DeFi, some projects enable decentralized passive fund management. DeFi's open source ecosystem allows users to easily track how their funds are managed and understand associated costs.

6. LOTTERY:

By applying DeFi principles to lotteries, we can eliminate custodianship through a smart contract on the Ethereum Blockchain.

• People in the lottery earn interest, and it goes to a random winner at specific times. When a winner is chosen, those who bought lottery tickets get their money back, ensuring no one loses.

7. PAYMENTS:

Cryptocurrency helps people exchange value without relying on a central authority. DeFi introduces creative payment methods.

• As DeFi is still new and changing quickly, it might bring new ideas to fix issues in the current financial system.

8. INSURANCE:

Insurance is like a safety net that provides financial protection in case something goes wrong. People commonly get insurance for cars, homes, health, and life.

• But in the world of DeFi, where tokens are locked in smart contracts, there's a risk of potential losses due to exploits.

• Even if projects audit their code, there's still uncertainty about safety, and hacks may occur.

• To protect against such risks, especially when dealing with significant funds in DeFi, purchasing decentralized insurance becomes important.

9. GOVERNANCE:

Governance in crypto is like managing a business. DeFi projects use governance tokens to let users vote on decisions and shape the project's direction.

• Various features and Dapps help streamline governance and work alongside current systems.

NOTE: Governance isn't precisely a DeFi category but that will be discussed further on.