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LearnCrypto 101

What is DeFi?

Lipsa Das
    What is DeFi?

    Key takeaways

    • Decentralized finance introduces financial services on the blockchain, without needing intermediaries like banks.
    • DeFi allows you to own your funds and access financial services instantly, anywhere and everywhere.
    • With your Phantom wallet, you can easily access DeFi to swap, borrow, lend, or stake your cryptocurrencies with just a few clicks.

    What is DeFi?

    DeFi, or decentralized finance, is a collective term for decentralized financial products and services on the blockchain, such as lending or borrowing.

    Simply put, DeFi is when the world of finance meets blockchain technology — you can make transactions and settle trades all via software. Confused? Stay with us while we get you up to speed.

    Why is DeFi important?

    To understand why crypto is best suited for finance, let’s think about why we use a bank. Banks act as an intermediary to ensure transactions happen smoothly.

    Roughly translating to: If I transfer $100 to someone, the bank’s ledger of accounts should accurately reflect that. Banks use centralized databases and thousands of employees to do billions of transfers like these across the globe.

    They also store our money and give us interest by lending it to others.

    While this system works, there are some drawbacks:

    1. Central banks and governments essentially wield authority over all aspects of the financial system, which includes the power to block individuals or restrict access to financial services.
    2. Banks can make poor lending choices leading to the inability to honor clients' withdrawal requests.
    3. Banks impose high processing fees, which disproportionately affect those who require their services the most.

    What if we could perform low-fee transactions securely without needing to trust a centralized entity to control our funds and to run the ledger?

    Enter DeFi. DeFi operates through smart contracts, which are self-executing segments of code containing agreement terms embedded within them. When the stipulated conditions are met, subsequent actions are executed automatically. Furthermore, these actions are transparent to all parties, reducing the need for trust. Essentially, DeFi enables the creation of "programmable" money on the blockchain.

    How does DeFi work with smart contracts?

    Let’s take a hypothetical example to see how decentralized finance works in practice. Say, you want to take a loan from a DeFi protocol. Instead of going through a ton of paperwork, bank tellers, and hidden processing fees, you just directly put up collateral in the protocol’s smart contracts. Once your collateral is deposited, the smart contract automatically releases the funds to you.

    It’s even possible to go a step further and set up a loan repayment schedule. First, you set the terms: a 12-month repayment schedule for your collateral with monthly installments. The smart contract takes care of the rest, automatically deducting the payments from your crypto wallet.

    Start exploring DeFi

    In the last couple of years, decentralized finance has seen massive innovation — it can essentially perform all aspects of traditional finance, such as trading, saving, lending, borrowing, interest, insurance, etc. Here are a few ways you can start exploring decentralized finance:

    Own your funds with Phantom

    Self-custody wallets like Phantom are core to the entire DeFi ecosystem. Your wallet acts as your pseudonymous digital identifier, which you can use to connect to decentralized applications (dapps). You can sign and approve trading transactions and easily purchase, store, swap, and stake cryptocurrency.

    Your wallet also provides true ownership of your funds while protecting them through cryptography. They're secured by your secret recovery phrase, a 12-word phrase that's a human-readable form of your private key. Your secret recovery phrase is the “key” to all your crypto funds — so it's crucial to store it safely.

    Swap crypto without middlemen

    Imagine you're traveling to another country for a vacation, and you want to exchange your US dollars for their local currency, say, pounds. Traditionally, you’d have to use a currency exchange booth at the airport, bank, or ATM to do this.

    Similarly, if you want to purchase or trade stocks, you usually go through a broker or a bank that facilitates the entire transaction.

    Swapping on a decentralized exchange does a similar job, but without needing you to depend on any third party. Instead, you can directly purchase or sell cryptocurrencies via the protocol’s smart contracts.

    If you want to swap cryptocurrencies, you can use Phantom’s in-app swapper to make swaps between tokens on Solana, Ethereum, and Polygon. You can also use a decentralized exchange like Uniswap. As the leading decentralized exchange for Ethereum and Polygon, Uniswap makes swapping and trading easy. You can connect your Phantom wallet, enter the trade details and press the “Swap” button to transact.

    Borrow and lend

    DeFi lending and borrowing protocols bring that vision of decentralized lending to life. For instance, a popular DeFi protocol AAVE allows you to access and lend funds on major ecosystems like Ethereum, Polygon, and Solana. As an example, let’s go with Polygon.

    Navigate to the Polygon market page on AAVE and connect your Phantom wallet. Once connected, you’ll be able to see all the supported assets — i.e, the ones you can borrow or lend.

    You can lend cryptocurrencies by choosing the “Supply” button for a yearly APY. This can also act as your collateral to borrow other cryptocurrencies against your initial supply.

    The protocol automatically allows you to borrow a certain amount of cryptocurrency. If your collateral amount dips significantly below your borrowed amount, the protocol’s smart contract uses the funds you’ve supplied to pay off your loan automatically.  And keep in mind, most of these tokens can be pretty volatile — so it’s vital to check your loan's health periodically.

    To sum up, AAVE allows you to lend cryptocurrencies and earn interest. You can also borrow cryptocurrencies by providing collateral.

    Step into the world of decentralized finance with Phantom

    As you can see, the possibilities continue to grow. New and innovative applications like NFT lending and borrowing and flash loans are being quickly adopted.

    Your Phantom wallet is the gateway to this entire ecosystem.  If you haven’t yet, download Phantom and read our setup guides to get started.