DeFi 101 for beginners

Welcome to the 11th edition of Mondays in Metaverse..

With inflation in US at its highest in 40 years, I thought it'll be interesting to get into the topic of earning higher interest rates on those dollars sitting in your bank account and losing value to inflation.

This week we dig into DeFi - Decentralized Finance. This is a deep topic, so this post will be a primer and I'll likely follow it up with a more of a deep dive in the next post.

What DeFi it not?

It’s almost easier to explain what Decentralized Finance is by explaining what it is not..

It is NOT centralized finance..

Centralized Finance is what you know finance as it is today. So, things like traditional banks, insurance companies, credit cards etc all of which involve a central trusted party belong to central/traditional finance (TradFi).

What are the challenges with TradFi?

In TradFi, the bank takes your money and lends it to someone else. And in the process, it takes a huge cut in the middle. Personal loans cost 10-15% while your savings account only pays you 0.01%.

But why do we need the bank?

Well, the bank establishes the trust in the middle.

You don’t know who to trust and can’t go giving out loans to random people on the street. So you give that job to the bank to vet the people. This was the best solution we had until like a decade ago.. But, with the advent of blockchain technology we have a better way to establish trust.

Thanks to the immutable, decentralized nature of blockchains, all the nodes on the network always have the same version of truth. You don’t need a central party to tell you the truth..

Benefits of DeFi

1. No Gatekeepers

DeFi enables peer to peer transactions without the need for central trusted party. It means no one can reject your application if they didn’t like your last name or skin color or for any other arbitrary reason.

2. Higher Interest Rates

DeFi removes the middle-man and all the charges and inefficiencies that come with it. Which means, it puts more money in your pocket. You can easily earn 10-12% interest on Stable Coins which is 1000 times better than 0.01% in TradFi.

3. Access to same high-quality financial services globally

DeFi is based on code and the same code can be accessed across the globe where ever you have internet. Doesn’t matter if a bank has a branch nearby or if no insurance company is available in your region. This can help bring many people who are ignored by TradFi into financial ecosystem.

Further there may be some services like Hedge Funds which may need hundreds of thousands of dollars in investments for access. This may lock you out of those potential higher returns. There is no such biasing in the world of DeFi. The smart contracts are open to everyone and apply the same way.

Getting started with DeFi - Understanding Crypto Wallets

For most people buying Cryptocurrencies means going to centralized exchanges such as Coinbase or Crypto.com etc. and buying listed tokens.

There’s a much bigger world of Decentralized Finance (DeFi) and a crypto wallet is your entry key to that.

What are Crypto Wallets?

Crypto wallets allow you to store your crypto assets. They are like your bank account, except for one big difference - "You are the bank".

When you install a wallet, you get a wallet address and a secret key. Your wallet address is like your bank account number (your public key) and your secret key is like your user id/password combination.

What do wallets enable you to do?

• Participate in DeFi - You lend/borrow against your coins or buy coins that are not yet listed on Centralized Exchanges.
• Earn better interest on stablecoins - Earn 10-15% interest on stablecoins without taking the volatility of crypto.
• Buy your first NFT token - Marketplaces such as OpenSea, Rarible etc. require you to connect a wallet, and that's where your NFTs will be stored.??

Understanding the Risks

"With great power comes great responsibility" - Uncle Ben

This quote from Spiderman movies is very apt for DeFi and in general for anything Blockchain or Decentralization related. The comfort of TradFi is that there are many safety nets built in.. If you make a mistake you can call customer support.. Yes, the 30-min wait is annoying but still you know there is someone who will help you out..

But with DeFi, you are on your own.

There are many horror stories of people sending their crypto to a wrong address or forgetting their private keys and in the process losing thousands and sometimes millions never to be recovered again. I made the same mistake but luckily lost only $200 and not a significant amount.

Now, you may be wondering why would you even want to take on this much more risk? Well the reason is that the returns are much higher in DeFi, and there is a lot more money to be made. As long as you keep a check on some of these basic things

1. Never share your private keys - Like I said, you are the bank. Never share the keys (secret key) to your bank with anyone. If those keys somehow get leaked, then your bank can get robbed. A common recommendation is write those on a piece of paper and store it in a secure location.
2. Double/Triple-check the account addresses during transfers - If you are transferring funds between your accounts or to a friend and you send it to a wrong address, that money is gone.. Forever.. There's no 1-800 number you can call to rectify the error.

Installing and Setting up Metamask

Now that you understand the risks. If you are still interested in getting your hands dirty, the first step would be to install a browser wallet. We can start with Metamask which is the most popular wallet.

Metamask is available as a browser plugin for Chrome, Brave, Firefox, Edge and also a mobile app on iOS and Android. Most (if not all) decentralized apps support Metamask so you’ll be able to complete most tasks with this wallet. Here are the steps for installation and configuration

1. Download and install browser plugin from https://metamask.io/download.html
2. Beware of phishing sites when downloading. Always download from official source.
3. From the screen with the option to “Import Wallet” or “Create new wallet” - Choose “Create new wallet”
4. The import wallet option is used when you are moving your wallet to a different browser/computer etc.
5. Setup a password
6. You’ll be using this password on a daily basis whenever you try to do any transaction.
7. Store your Keys
8. The best way to do this is to write the keys on a piece of paper and store the paper in a secure fire-proof/water-proof place like a bank locker.
9. This is a super important step, I’ll cover more about this in my next post.
10. Validate the keys
11. In the next screen, Metamask will ensure you have noted down the keys correctly by asking you to verify.

Play around with your wallet

Congratulations, your wallet has been installed. Your first Ethereum account with 0 ETH is ready

You can start now play around with your wallet.

A to-do for you - try creating a multiple accounts.

You don’t need to go to any bank or need anyone’s permissions, you can do whatever you want in your bank, with the click of a button.

Different wallets for different blockchains

Wallets are blockchain specific.

Metamask is the most popular wallet for Ethereum. It also works for L2s, side-chains and EVM compatible L1s that I covered in my earlier post.

For other blockchains, you need different wallets. Some examples include -

• Solana - Phantom
• Terra - Terra Station Wallet
• Cosmsos - Kepler

TL;DR

That's enough for this post. Next time, we can dig deeper into the topics of wallet and also discuss some tools on how to navigate the world of DeFi.

Here's a quick recap of this post.

• DeFi is Decentralized finance which is the opposite of Traditional Finance - TradFi..
• It removes the middle-men, the gate keepers and thus unlocks higher returns and access to services that you wouldn't otherwise have
• DeFi is risky with very little safety nets, and you need to assume more responsibility to earn better returns.
• Crypto Wallets are your doorway to the world of DeFi
• Metamask is one of the most popular browser wallets for EVM compatible chains. Different blockchains use different wallets.