What is DeFi? A Comprehensive Breakdown of Decentralized Finance. - YouTube

Hello cadets!

For the past year, Decentralized Finance, or DeFi has exploded in the crypto space.

It comes from taking traditional financial services like borrowing, lending, trading,

and insurance - and turning them on their heads.

All made possible by running these services through smart contracts on the Ethereum platform

and other smart contract platforms.

Join me to learn more about the beautiful new world of DeFi.

This episode is sponsored by Bittrex Global, where you can trade top DeFi tokens without

paying gas fees.

I’m Captain Crypto and welcome to Cryptonauts.

There are five unique traits about DeFi that make it stand out from traditional finance.

First, no third parties, everything runs entirely through smart contracts.

There are no loan officers to talk to, there are actually no humans at all.

Second, it’s governed by the users.

Most DeFi services offer governance tokens, where users can take part in voting and deciding

how certain platforms are run.

Third, it’s easy to enter... for now at least.

No one needs to know your name, or where you live, you just need a crypto wallet, like

MetaMask, and you’re good to go.

That said, without any regulation comes a lot more risk.

Fourth, DeFi is community driven, meaning many of the DeFi projects are open-sourced,

and new iterations of original projects can drive variety and innovation in a short amount

of time.

And last, DeFi is truly global, no single product or service is tied to any country

and all users are welcome.

So what makes DeFi Possible?

There are 3 crucial aspects that you need to know about: decentralized exchanges, liquidity

pools, and oracles.

You may have heard of centralized exchanges like Coinbase, Binance, or Bittrex Global.

The main difference between a centralized exchange and a decentralized one is that your

cryptocurrency is under the custody of the centralized exchange...meaning you technically

do not own your crypto.

This is why millions of dollars were stolen from centralized exchanges in the past.

Obviously today’s security is a lot better than before, but the custody problem still

remains, which is why the exchanges we mentioned before all have hundreds of millions of dollars

in insurance in case anything happens.

Now with a decentralized exchange, your crypto stays in your wallet and directly interacts

with the blockchain to trade crypto.

The crypto remains under your custody at all times.

However, original Decentralized Exchanges, or DEXs, were really slow, complicated, and

peak usage resulted in high gas fees, compared to centralized exchanges that are fast, popular,

and don’t have gas fees.

Sadly DEXs didn’t catch on.

Enter Automated Market Makers and Liquidity Pools…

An automated market maker (or AMM) is basically a smart contract where a user can perform

a trade by sending their ETH to a liquidity pool, and the AMM smart contract calculates

how much of a token - for example DAI - they receive back.

An AMM is essentially a new breed of decentralized exchanges that matches trades based on mathematical

formulas, but it couldn’t be possible without a liquidity pool.

A liquidity pool is created when a liquidity provider must enter an equal amount of a pair

of ERC20 Tokens.

So if you put in 1 ETH worth $400, you must also put in an equal value amount of another

token like 400 DAI.

The reason is threefold: first you help reinforce the price of the token to prevent it from

losing value, second you receive a liquidity provider token representing your ownership

in the liquidity pool, and third is so that you can earn a percent on every trade.

All of these new DEX features have helped incentivize thousands of crypto users to invest

in liquidity pools and this faster, more efficient way of performing decentralized trades has

led to popular AMM’s like Uniswap, Curve, and Balancer.

However, AMMs are still not perfect, there are issues like hackers exploiting the smart

contracts to produce price manipulation.

One way to combat this, and our next item on the DeFi list, is Oracles.

Oracles, or more specifically price oracles, are crucial to the security of protocols because

their main purpose is to keep token prices consistent with global market prices.

Without an accurate price, hackers can easily manipulate the price of a token on an exchange.

The best example of an accurate oracle is the Uniswap v2 Price Oracle.

It first measures the price of a token at the beginning of a block, and then creates

a price cumulative that includes time between blocks.

This just means that an attacker would have to price manipulate two consecutive blocks

to be successful.

However in reality it ends up being so expensive that any potential profit wouldn't be worth

it.

As you can see, we’ve come a long way to make DeFi efficient and reliable.

But what else can you do with DeFi?

What makes it stand out from traditional finance?

One great DeFi innovation is Compound Finance - some of you may know it as Yield Farming.

Let's get into it.

If you currently have money sitting on an exchange doing nothing, then you’re missing

out on earning interest.

To get your crypto to work for you, you can move your crypto to the Compound platform

and earn yearly interest.

For example, after you buy DAI from Bittrex Global, if you deposit DAI into Compound,

you’ll earn 2.9% a year, way better than any traditional savings account.

It doesn’t even have to be DAI, it can be other tokens like ETH or USDC that earn different

interest rates.

As you can see from the chart, supply and demand determines the interest rates.

Now, knowing that different tokens can earn different interest rates, people have taken

to moving their crypto assets around to generate the most returns possible.

As an example, let's say you place 100,000 USDT into Compound, you get a liquidity pool

token called cUSDT worth almost exactly 100,000 USDT.

You can now take your cUSDT to another platform called Balancer, and invest it in their liquidity

pool to earn a small amount in transaction fees.

You’re basically chasing the greatest yields, or yield farming.

The beauty of DeFi is that you can stack your trades into a dozen moves like lego blocks,

as you can see here from this FuruCombo example.

This reminds me a lot of the guy who traded a red paperclip, and in a series of trades,

eventually traded for a house.

You keep trading until you get the best returns.

As with all things blockchain-related there are security risks.

As a warning to possible users of the DeFi platforms, always use best practices with

your wallet and private keys while also being sure to invest responsibly on these platforms.

It is still a very speculative environment, and returns on yield farming are not always

guaranteed.

There’s always the risk of bugs, exploits and thefts, so please invest cautiously.

The DeFi space is set up for huge financial innovation in the near future and it’s just

getting started.

In this year alone, the amount of money invested into DeFi platforms has gone from 1 billion

in June to over 10 billion by October, in just a few short months!

Of course some aspects of DeFi still involves a lot of risk and it’s still 3-5 years away

from becoming a mature technology, but I promise you that if you get into the space now, you

won’t regret it.

Huge thanks to Bittrex Global for sponsoring this episode, and if you haven’t already,

give a like and subscribe for more videos on DeFi and blockchain.

Remember, HODL, secure your crypto and may Satoshi and Vitalik be with you, always.