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What is DeFi? A Beginner’s Guide to Decentralized Finance - YouTube
Channel: 99Bitcoins
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What is DeFi?
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Can I use it to earn interest
on my cryptocurrency holdings?
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Is it risky?
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And will it really change
the future of finance as we know it?
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Well, stick around.
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Here on Crypto Whiteboard Tuesday,
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we’ll tackle these questions and more.
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Hi, I’m Nate Martin
from 99Bitcoins.com
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and welcome
to Crypto Whiteboard Tuesday
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where we take complex
cryptocurrency topics,
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break them down and translate them
into plain English.
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Before we begin,
don't forget to subscribe to the channel
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and click the bell
so you’ll immediately get notified
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when a new video comes out.
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Today’s topic is decentralized finance,
or DeFi for short.
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If you’ve watched our previous videos
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you already know that Bitcoin
is a form of money
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that isn’t controlled
by any central bank or government.
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It can be transferred to anyone
from anyone around the world,
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without the need of a bank
or a financial institution.
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Bitcoin is decentralized money,
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and if you’re just starting out
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you may want to catch
our “What is Bitcoin” video
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before moving forward.
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However, transferring money
is only the first of many building blocks
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in a financial system.
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Aside from sending money
to one another,
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there are a variety of services
we use today.
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For example, loans, saving plans,
insurance and stock markets
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are all services
that are built around money
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and together create
our financial system.
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Today, our financial system
and all its services
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are completely centralized.
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Banks, stock markets,
insurance companies
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and other financial institutions
all have someone in charge,
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whether it be a company or a person,
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that controls and offers these services.
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This centralized financial system,
or CeFi for short, has its risks -
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mismanagement, fraud
and corruption to name a few.
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But what if we could decentralize
the financial system as a whole
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in the same way
Bitcoin decentralized money?
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That’s exactly what DeFi is all about.
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DeFi is a term
given to financial services
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that have no central authority
or someone in charge.
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Using decentralized money,
like certain cryptocurrencies,
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that can also be programmed
for automated activities,
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we can build exchanges,
lending services, insurance companies
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and other organizations
that don’t have any owner
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and aren’t controlled by anyone.
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Confused?
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Don’t worry,
we’ll break it down for you…
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In order to create
a decentralized financial system,
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the first thing we need
is an infrastructure
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for programming and running
decentralized services.
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Luckily for us, Ethereum does just that.
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Ethereum is a Do It Yourself platform
for writing decentralized programs
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also known as decentralized apps
or Dapps.
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Our “What is Ethereum” video
explains Ethereum in great detail,
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but for now we’ll just say
that through the use of Ethereum
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we can write automated code,
also known as smart contracts,
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that manage any financial service
we’d like to create
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in a decentralized manner.
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This means that we determine the rules
as to how a certain service will work,
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and once we deploy those rules
on the Ethereum network
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we no longer have control over them -
they are immutable.
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Once we have a system in place
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like Ethereum
for creating decentralized apps
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we can start building
our decentralized financial system.
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Now let’s take a look at some of
the building blocks that comprise it.
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The first thing any financial system
needs is of course money.
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You may be thinking:
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“why not use Bitcoin or Ether,
which is Ethereum’s currency?”
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Well, as for Bitcoin,
while it is indeed decentralized,
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it has only very basic
programmable functionality
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and is not compatible
with the Ethereum platform.
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Ether, on the other hand,
is compatible and programmable,
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however it is also highly volatile.
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If we’re looking to build
reliable financial services
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that people will want to use
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we’ll need a more stable currency
to operate within this system.
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This is where stablecoins come in.
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Stablecoins are cryptocurrencies
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that are pegged to the value
of a real world asset,
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usually some major currency
like the US dollar.
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Our video “What are stablecoins”
explains in more detail
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how stablecoins are created
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and what the different types
of stablecoin pegs are.
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Make sure to check it out if you want
some additional information.
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For the purpose of DeFi
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we’ll want to use a stablecoin
that doesn’t use fiat money reserves
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for maintaining a peg,
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since this will require
some sort of central authority.
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This is where DAI comes into play.
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DAI is a decentralized cryptocurrency
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pegged against the value
of the US dollar,
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meaning one DAI equals one US dollar.
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Unlike other popular stablecoins
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whose value is backed directly
by US Dollar reserves,
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DAI is backed by crypto collaterals
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that can be viewed publicly
on the Ethereum blockchain.
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DAI is over collateralized,
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meaning if you lock up in a deposit
$1 worth of Ether,
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you can borrow 66 cents worth of DAI.
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As soon as you want your Ether back,
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just pay back the DAI you borrowed
and the Ether will be released.
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If you don’t have any Ether
to lock up as collateral
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you can just buy DAI on an exchange.
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Because DAI is over collateralized,
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even if Ether’s price
becomes extremely volatile,
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the value of the locked Ether
backing the DAI in circulation
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will most likely still remain
at 100% or more.
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In essence, the DAI stablecoin
is actually also a smart contract
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that resides on the Ethereum platform.
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This makes DAI a truly trustless
and decentralized stablecoin
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which cannot be shut down
nor censored,
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hence it’s a perfect form of money
for other DeFi services.
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Now that our decentralized
financial system
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has stable decentralized money,
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it’s time to create
some additional services.
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The first use case that we’ll discuss
is the decentralized exchange,
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or DEX for short.
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DEXes operate
according to a set of rules,
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or smart contracts,
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that allow users to buy, sell,
or trade cryptocurrencies.
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Just like DAI they also reside
on the Ethereum platform
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which means they operate
without a central authority.
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When you trade on a DEX,
there is no exchange operator,
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no sign-ups, no identity verification,
and no withdrawal fees.
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Instead, the smart contracts
enforce the rules, execute trades,
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and securely handle funds
when necessary.
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Also, unlike a centralized exchange,
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there’s often no need to deposit funds
into an exchange account
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before conducting a trade.
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This eliminates the major risk
of exchange hacking
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which exists for all centralized
exchanges.
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But the range of decentralized
financial services doesn’t stop there.
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Let’s move on to decentralized
money markets -
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services that connect borrowers
with lenders.
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Compound is an Ethereum based
borrowing and lending dapp,
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meaning you can lend your crypto out
and earn interest on it.
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Alternatively,
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maybe you need some money
to pay the rent or buy groceries,
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but the only funds you have
are cryptocurrencies.
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If that’s the case you can deposit
your crypto as collateral,
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and borrow against it.
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The Compound platform automatically
connects the lenders with borrowers,
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enforces the terms of the loans,
and distributes the interest.
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The process of earning interest
on cryptocurrencies
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has become extremely popular lately,
giving rise to “yield farming” -
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A term given to the effort
of putting crypto assets to work
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while seeking to generate
the most returns possible.
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You can take a look
at the description below this video
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for some of the more exciting
DeFi projects
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that you can start using today.
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So we have decentralized stablecoins,
decentralized exchanges
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and decentralized money markets.
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How about decentralized insurance?
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All of these new financial products
definitely entail some risks
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which we will cover shortly,
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so why not create a service
that insures my funds
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in case something goes wrong?
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Well, how about
a decentralized platform
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that connects people
who are willing to pay for insurance
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with people who are willing
to insure them for a premium,
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while everything happens autonomously
without any insurance company
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or agent in the middle.
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DeFi services work in conjunction
with one another,
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making it possible to mix
and match different services
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to create new
and exciting opportunities.
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This kind of resembles how you can
use different LEGO blocks
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and get creative with whatever it is
you want to build.
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Hence the term ‘money legos’
has been coined to refer to DeFi services.
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For example, you can build
the following service
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from different money legos -
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You start out by using
a decentralized exchange aggregator
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to find the exchange
with the best rate
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for swapping Ether for DAI.
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You then select the DEX you want
and conduct the trade.
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Then you lend the DAI you received
to borrowers to earn interest.
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Finally, you can add insurance
to this process
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to make sure you’re covered
in case anything goes wrong.
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That’s just one example out of
the many opportunities DeFi offers.
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By now you can probably imagine
what advantages DeFi presents.
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Transparency, interoperability,
decentralization,
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free for all services
and flexible user experience,
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to name just a few.
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However there are also some risks
you should be aware of.
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The most important risk is that DeFi
is still in its infancy
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and this means
that things can go wrong.
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Smart contracts have had issues
in the past
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where people didn’t define the rules
for certain services correctly
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and hackers found creative ways
to exploit existing loopholes
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in order to steal money.
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If you decide to test out
any of the existing DeFi services,
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make sure to do it
with an amount of money
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you can afford to lose
in case anything goes wrong.
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Additionally, you should remember
that a system is decentralized
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only as its most central component.
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This means that some services
may be only partially decentralized
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while still keeping
some centralized aspects
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that can act as an achilles heel.
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It’s important to understand
exactly how a product or service works
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before investing in it
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so you can be aware of any issues
that may come up.
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To sum it up,
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it seems that the DeFi revolution
has reached its early adopter stage
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and the coming years will tell
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if it manages to cross the chasm
into mainstream adoption.
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There’s no doubt
that a decentralized financial system
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can benefit a huge portion
of the population
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that currently suffers
from financial discrimination,
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high fees and inefficiencies
in managing their funds.
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That’s it for today’s episode
of Crypto Whiteboard Tuesday.
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Hopefully by now you understand
what DeFi is -
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a term given for a variety
of decentralized financial services
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that aim to replace our current
centralized financial system.
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You may still have some questions.
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If so, just leave them
in the comment section below.
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And if you want to take a look
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at some of the more popular
DeFi services in the works today
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just check out the list
in the description below.
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Finally, if you’re watching this video
on YouTube,
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and enjoy what you’ve seen,
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don’t forget to hit the like button,
subscribe to the channel
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and click that bell
so that you’ll be notified as soon
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as we post new episodes.
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It really helps us out a lot.
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Thanks for joining me
here at the Whiteboard.
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For 99bitcoins.com,
I’m Nate Martin,
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and I’ll see you…in a bit.
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