How are crypto and DeFi defined?
The prospect of decentralization has created a rapid shift in how users understand and perceive new technological advancements that’s why it’s essential to highlight differences between terms. Crypto is a blockchain-secured virtual currency that provides utility to the decentralized network, whereas DeFi represents a range of decentralized financial services that use various cryptos as an exchange unit.
As more people gain exposure to blockchain technology as a whole, there seem to be a lot of misconceptions in terms of what each term actually means. A 2021 survey has revealed that 1 in 3 people that have invested in cryptocurrencies over the past year know almost nothing about the tokens they’ve invested in. This further emphasizes the need to clarify the meaning of each word and particularly each type of blockchain byproduct that is currently in the market.
How do they work?
To answer that question, we must first emphasize that crypto and DeFi are based on blockchain technology. Blockchain is a decentralized system of networks that uses network validations to accept and add transaction blocks to the blockchain. Simply put, a blockchain does not rely on a centralized entity and uses a consensus mechanism formed out of network participants.
Crypto or cryptocurrency is a decentralized virtual currency used for peer-to-peer transfers on the blockchain network. DeFi, on the other hand, is an abbreviation of Decentralized Finance which allows users to access a network system and use financial services. DeFi uses cryptocurrencies as a unit of exchange as cryptocurrencies like Bitcoin have been developed as a peer-to-peer system to bypass centralization and prevent government censorship.
Crypto is the virtual token used on blockchain protocol to facilitate transfers or provide utility by accessing new platform features – like using smart contracts on Ethereum.
DeFi allows users to borrow, lend, swap, and transact cryptocurrencies within the parameters of its blockchain protocol. By offering new avenues for marginalized groups to access banking-like features, all within a decentralized network, DeFi protocols create new use cases for blockchain technology and help bypass governmental gatekeepers.
Each DeFi protocol is developed on an existing blockchain protocol. The most popular network is Ethereum; however, according to DeFiLlama, Ethereum TVL DeFi dominance has shrunk to 50%. This is because high Ethereum fees and other Layer 1 protocols provide cheaper and faster transaction outputs.
In sum, crypto is the virtual currency used as a unit of exchange on blockchain protocols. Tokens can have different utilities; however, DeFi protocols use native protocol tokens (crypto) to provide network incentives, reward stakers who secure and validate the network, or those who provide liquidity to the network.
Crypto or DeFi?
Ethereum is the primary catalyst that prompted a DeFi surge in 2020 and helped protocols gain market popularity. Ethereum or other Layer 1 blockchain with smart contract capabilities allow users to create decentralized and self-sufficient contacts between one another. Users rely on blockchain trustworthiness to interact with financial products by removing third parties from the approval process. In addition, the process is more dynamic because DeFi platforms use a decentralized oracle network to ensure price data on the platform is accurate. This enables users to see the correct conversion price of a cryptocurrency.
Crypto is used for peer-to-peer transfers without involving any third party in the transaction process. Instead, nodes or network validators approve transactions, and each blockchain protocol has its own consensus mechanism. The most popular one was proof of work – akin to Bitcoin. However, Ethereum mining is a safer and less energy-consuming mechanism. Thus in Proof-of-stake (POS) token holders become part of the validation process.
While crypto is a safe and affordable way of sending digital currencies across the network, they are not as risky simply because established protocols are less prone to network hacks. Crypto is, however, dependent on its own protocol. This means that users must interact with other token holders from the same protocol to transfer tokens successfully.
DeFi, on the other hand, is a more risky blockchain product because it developed innovative ways of securing and rewarding participants. According to Certik data, DeFi protocols have lost over $1.3 billion in funds during 2021, and the same security firms also highlighted centralization as the “most common vulnerability” among DeFi hacks.
Interacting with DeFi is dangerous and sometimes scary, especially if users deposit their funds on newer platforms that offer higher yields. While already established DeFi protocols provide a level of security since they also cater to institutional investors, DeFi protocol users should only interact with battle-tested protocols and should sacrifice higher ROIs for increased security.
As cryptocurrency and blockchain development grows further, we expect to see new ways for DeFi protocols to provide value to their users and maximize the use of crypto in the developing digital structure.
More information about crypto and DeFi
Both crypto and DeFi are new technologies and you can learn more in the following blogs:
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