How DeFi works

What happens when finances get decentralized?

The way we use traditional financing right now is best described by George Bailey in It’s a Wonderful Life during the bank run scene (if you haven’t seen it, you should):

“You're thinking of this place (the traditional financial institution) all wrong. As if I had the money back in a safe. The money's not here. Your money's in Joe's house...right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why, you're lending them the money to build, and then, they're going to pay it back to you as best they can.”

With decentralized finance there will be no Building and Loan or any other institutional third party. Instead your loan would be a smart contract living on the blockchain and abiding by its rules and your terms and conditions.

This guy, who's an unfavorable candidate for credit through traditional banks, is paying off his refinanced mortgage using a DeFi lending system. He put up the collateral for the loan he needed in an undisclosed cryptocurrency. The crypto he used as collateral stays in the market — he’s borrowing against it, not spending it. And he chose to lock in a fixed rate for six months before reevaluation of the interest rate. That way if the price of his crypto-collateral tanks he’s not locked in. And he’s able to be his own lender with no approval from any bank because DeFi eliminates the need for a credit score.

He put up the collateral for the loan he needed in an undisclosed cryptocurrency. The crypto he used as collateral stays in the market — he’s borrowing against it, not spending it.

A big reason that everyone you know isn’t taking out this kind of loan right now is because the only form of collateral accepted on these exchanges is crypto. And you often need to have around 150% of the value of the loan you’re taking out as collateral.

If you want another way to get involved in DeFi, you could set out to earn interest on your holdings. In crypto it’s called yield farming and it began as a system where traders would offer short term loans with high interest rates to other crypto traders and collect the gains for themselves. Now DeFi exchanges do the work for you, creating an opportunity for passive investors to earn money on crypto.

As with everything in crypto, there’s risk involved. Do your research before making any moves. And good luck making gains!