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What is DeFi?

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What is DeFi?

Decentralised finance (or DeFi) is a system where users can gain access to financial products like cryptocurrency lending and borrowing without the need to consult centralised institutions like banks. This is because DeFi is structured on a peer-to-peer basis and is powered by blockchain technology and the use of cryptocurrency.

DeFi platforms are open to anyone and transactions executed on them are recorded on digital ledgers that act as public records. Users normally need to give away little or no private information in order to participate in the system. This is unlike the layered Know Your Customer or Anti-Money Laundering criteria users must meet if they want to register with a bank or enjoy the full swathe of financial services they offer.

DeFi platforms are also a more flexible option for people looking to lend, borrow, and trade cryptocurrencies because they operate 24 hours a day, 7 days a week. DeFi often offers lower transaction costs and faster settlement times than traditional banks.

In many ways, this makes decentralised finance a sector that is increasingly threatening the monopoly held by the traditional banking system on financial opportunities.

What is Staking?

Staking is the practice of locking up cryptocurrency in return for rewards in the form of more crypto tokens. Users can stake cryptocurrency on Proof of Stake (PoS) blockchains. Staking is crucial to the network security of Proof of Stake blockchains.

Staking cryptocurrency empowers users to participate in the governance or to potentially change the rules of how a blockchain functions. Users who stake crypto tokens can vote on whether any upgrades or new features should be added to a Proof of Stake blockchain.

Staking is the equivalent to mining in Proof of Work blockchains like Bitcoin. But staking consumes far less energy than mining and has a lower barrier to entry because users don't need to compete with expensive computer hardware to start earning passive income.

To stake cryptocurrency, all that is required is for users to connect a wallet to a staking service and deposit it into special blockchain-based smart contracts, which are basically strings of computer code. No specialist knowledge is necessary and this can often be done in a few clicks. The longer users stake their cryptocurrency, the more interest or yield they gain.

This makes staking something like giving out a loan that is paid back with regular interest added on top. Users can receive payouts on a daily or weekly basis depending on which entity, staking service or blockchain they decide to stake their cryptocurrency with.

What are Centralised and Decentralised Exchanges?

Exchanges are online marketplaces where you can buy, sell, and trade cryptocurrency. There are two main types of exchanges: centralised and decentralised.

Centralised exchanges (CEXs), such as Coinbase or Binance, mainly act as intermediaries matching up buyers and sellers trading their cryptocurrency at market prices. A large number of them also let users use products like leverage and derivatives when making trades. In this sense, CEXs are not so different from traditional exchanges like stock exchanges.

Centralised exchanges can also act as custodians if users choose to store their cryptocurrency in the digital hot wallets integrated with their platforms. If users do this, it means they are trusting the exchange to keep their crypto safe.

This is comparable to depositing money with a bank; but it also comes with similar risks. If the exchange goes bust, you may not get your money back.

Regulated centralised exchanges must comply with anti-money laundering (AML) and combatting the financing of terrorism (CFT) laws. This means users usually have to complete KYC (Know Your Customer) checks to verify their identity before they can transfer fiat currency (such as dollars or euros) to their accounts.

Centralised exchanges account for the vast majority of liquidity and trading volume in the crypto market. But decentralised exchanges (DEXs) are also popular among traders. DEXs are peer-to-peer platforms that eliminate the need to rely on a third party to pair up buyers and sellers.

Decentralised exchanges execute trades by relying on smart contracts, lines of computer code that automate processes on the platform. Unlike centralised exchanges, DEXs do not serve as custodians and users cannot store crypto with them. Users can only make trades on a DEX by connecting to the platform with a private hot wallet that has crypto stored in it.

Decentralised exchanges are inherently unregulated and permissionless, so anyone can use their services without giving away their identity. DEXs are appealing to some traders because of the relatively cheap transaction fees associated with them compared to their centralised counterparts.

What are Hot Wallets and Cold Wallets?

Hot wallets are online software wallets that you can use to store your cryptoassets on the web. You can access your hot wallet from anywhere in the world as long as you're plugged into the internet and know your password or “seed phrase”.

Cold wallets are individually-owned pieces of hardware that store cryptoassets totally offline.

There are advantages and disadvantages to both types of cryptocurrency storage. Because hot wallets are always connected to the internet they can be more vulnerable to attack. However they do make it easier for users to trade or spend their crypto. Cold wallets are not internet connected. So while they are less convenient, they are more secure.

A cold wallet is most like a home safe, while a hot wallet may resemble a safety deposit box you'd find in a bank. In the first scenario, you are in full custody of your cryptoassets. In the latter, you place your trust in an external party to custody your cryptoassets for you.

Cold wallets can be relatively costly while hot wallets are usually provided for free. Users will also always need physical access to their cold wallet to use it. This is not the case with hot wallets which enable users to transfer or withdraw crypto with ease using any smartphone or computer.

What are stablecoins?

Stablecoins are digital assets pegged to the value of currencies, commodities, or other traditional assets. For example, the stablecoin EUROC mirrors the price of the Euro.

Some stablecoins are pegged one-to-one to the price of national currencies like the US dollar or the euro, while others are pegged to the value of stable assets, like gold. The intention is that stablecoins should track and hold a specific pre-defined value.

Unlike Bitcoin, no new stablecoins can be created by mining. It is specified in the code of these stablecoins that no new coins can be minted or issued into the market by people other than those that control them centrally.

Whereas national currencies are issued and managed by central banks, stablecoins are issued and managed by private companies. The two most well-known and most popular stablecoins are Tether (USDT) and USDCoin (USDC). Both are asset-backed stablecoins pegged one-to-one against the US dollar.

Stablecoins retain the benefits of cryptocurrencies because transactions involving them are peer-to-peer, low cost, near-instant, and recorded on a public blokchain. Stablecoins bypass the volatility of cryptocurrencies because their price is tied to more stable assets.

It is important to remember that stablecoins are not always physically backed by the asset they represent. By this measure, there are a few different types of stablecoins.

When it comes to stablecoins tied to the value of fiat currencies, we can point to those that are cash-collateralised, crypto-collateralised, and uncollateralised.

The stablecoin USDC is 100% backed by cash reserves stored in financial institutions, while USDT is partly backed by cash in addition to various securities like bonds and commercial paper. On the other hand, the stablecoin DAI is crypto-collateralised, by a basket of cryptocurrencies like Ethereum.

What are the types of stablecoins?

The two main types of stablecoins are asset-backed stablecoins and algorithmic stablecoins.

Asset backed stablecoins are backed by, and derive their value from, a basket of cash and cash-equivalent assets, such as bonds or money market funds.

Uncollateralised stablecoins are also known as algorithmic stablecoins. They use computer algorithms to maintain a consistent value on the basis of supply and demand. They are generally more vulnerable to losing their peg because they have no real underlying value, unlike their collateralised peers.

What are stablecoins used for?

The idea behind stablecoins is to make it easier for people using cryptocurrency to carry out transactions like buying goods and services or to earn interest on their crypto holdings.

Users can deposit their stablecoins into decentralised finance (DeFi) platforms and earn rewards (yield) on these holdings. Many DeFi platforms offer higher rates of return than traditional banks do for fiat currency deposits, in order to attract stablecoins users to use their services.

Stablecoins can be sent and received from and to peer-to-peer crypto wallets, which don't require a bank to function. Because of this fact, stablecoins have broadly been recognised to have the potential to improve efficiency and lower the costs of making cross-border transactions, as well as increasing competition and disrupting the monopolies of banks, thereby fostering broader financial inclusion for millions of people across the world.

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