Cryptocurrency and the decentralized finance movement provide better access to funds for people that may have been marginalized, but increased access doesn’t come without added risk.
As an industry, decentralized finance, or DeFi, provides greater transparency and entry points for borrowers as the scope of DeFi is a peer-to-peer transaction of digital assets without an intermediary’s oversight and reach.
Defi products gain their value from the demand for a token, and the number of available tokens on the market help drive their price upward, which can lead to volatility in the value of a DeFi asset.
In traditional finance, currency maintains its value through the backing of a government or Central Bank. These institutions help control the value of a currency by the amount they allow in circulation at any given time, which stabilizes the currency.
For investors looking to take a little more risk with the opportunity for much higher yields, DeFi products can be very intriguing.
To start with DeFi investing, an individual would need to deposit fiat currency into an exchange account specializing in digital assets like a decentralized exchange.
What Is A Decentralized Exchange
A decentralized exchange is a digital currency exchange that provides users to buy and sell cryptocurrency through direct, peer-to-peer transactions without an intermediary.
A decentralized exchange gives users and peer-to-peer transactions more control than traditional exchanges with greater control over their platforms.
A decentralized exchange is a platform that people use to buy, trade, or sell their cryptocurrency through an encrypted format known as cryptography.
There are three main types of decentralized exchanges, each providing unique advantages for the kinds of exchanges that may need to occur on the platform.
The three main types of decentralized exchanges are the Automated Market Maker (AMM), Order Books, and DEX Aggregators.
Automated Market Maker: Automated Market Maker, or AMM, fulfills orders and tracks digital asset prices through smart contracts. A smart contract is a digital device that allows users to transfer ownership to a second party.
AMMs are popular because the value of a digital asset may vary on a different exchange, so having some liquidity allows arbitrageurs an advantage of buying on one exchange at a lower price and reselling those assets at a higher price.
Order Books – Off-Chain And On-Chain: Order books mirror centralized exchanges by providing the ability to place buy orders at a designated price and sell orders when a price meets the set price.
There are two types of order books;
Off-chain order books are order books that are hosted by a central authority outside a distributed ledger.
On-chain order books allow users to buy and sell digital assets without taking physical custody of the digital asset.
DEX Aggregators: DEX aggregators work much like a decentralized search engine for a decentralized exchange, eliminating the need for manual searches for the best digital asset price.
These platforms allow for minimal slippage of large orders, lower trading fees than other exchanges, and offer optimal prices on tokens and other digital assets.
There are three types of digital assets to consider for investments. These digital assets are known as;
Cryptocurrency, NFTs, And Stablecoins
There are a few different forms that DeFi can take, from cryptocurrency, NFTs, and Stablecoins. Understanding each type of digital currency and how they gain value is essential for anyone looking to invest in these types of investment vehicles.
Cryptocurrency: Cryptocurrencies are digital assets that are assigned value through the available number of coins in the blockchain and the demand for those coins by others. Crypto is a peer-to-peer electronic transaction that eliminates the need for intermediaries like banks and other traditional financial institutions.
Crypto can be traded, used as cash, and bought or sold like any other asset and has become more widespread in everyday use.
Common forms of crypto include Bitcoin, Ethereum, and others.
NFTs: NFTs are short-hand for non-fungible tokens, which are a form of digital asset that can’t be replicated or duplicated. These one-of-a-kind assets can be electronic or in physical form, and as they are unique and singular, these assets cannot be sold or traded without using a smart contract that transfers ownership to a second party.
Stablecoins: Stablecoins are digital assets that are backed by fiat currency, such as the USD Coin, and gain their value much like traditional currencies. As a central authority supports these assets, their value is more stable and less volatile, hence the name “stablecoins.”
As DeFi becomes more accepted, the peer-to-peer aspect of transactions will increase in time. Much like the increased reliance on the internet, crypto is the future of finance.
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