DeFi savings explanation so that even a Mom can understand it
Mom: What is DeFi?
Me: DeFi means Decentralized Finance. Like, you buy fruits from the local market, that local market can be treated as a centralized fruit market, as they sell fruits at a higher rate than what farmers sell to them. What if we buy directly from farmers? In this case, it’s decentralized because it removes intermediaries like the local sellers and wholesalers. Like during COVID-19, few local fruit sellers were available and were selling fruits at a very high rate. It is called centralized & decentralization removes this totally. In a similar way, banks can hold/block our money without even informing us, or in case of demonetization, the government suddenly announces that 500/1000 rs note will be illegal after a date. And we have to stand in long queues to exchange them. Decentralization removes this totally. All the intermediaries banks and financial institutes will be removed, there will be no centralized authority, or a single group/person will not have the power to make a decision. We call this system a Decentralized Finance (DeFi).
Mom: Why do we need DeFi?
Me: Mom as already explained, traditional banks have lots of downsides. Like
- We actually do not have power over our hard-earned money.
- There is a lot of mismanagement in banks, like, what if our FD paper is lost, that will be a huge issue for us.
- Sometimes there is fraud and corruption by a single person or by a group. This is an unavoidable possibility as a middleman is always required in traditional banks. So Decentralized Finance (DeFi) is what we need to resolve these issues.
Mom: Give me some examples of DeFi
Me: DeFi is a wallet, powered by open and permissionless finance. We can buy crypto, swap tokens, and earn interest. Mom most importantly, only we have access to our money.
Mom: How does DeFi generate this interest?
Me: As Minke has access to Aave and mStable, which are smart contracts that facilitate peer-to-peer lending and lets us save and earn a yield on stablecoins. This is called yield farming.
Mom: What is yield farming?
Me: Yield farming refers to the process of earning on your crypto assets. We as a saver, can deposit stablecoins and earn interest from borrowers who borrow them. For a digital asset, borrowing rates are usually higher than the lending rates.
Mom: Why the APY is so high?
Me: Due to various reasons like
- Borrowers usually pay higher interest for digital assets compared to traditional asses
- Smaller margin between saving interest and borrowing interest of DeFi. This gives DeFi the possibility to generate higher APY.
- In traditional banks saving interest is around 3-6 % while borrowing interest is around 10-24 %. This is due to the fact that traditional banks require physical infrastructure, while DeFi does not require it. Due to this DeFi gives a high APY (annual percentage yield)
Mom: What's more?
Me: Yes there is more, Landing our money (providing liquidity) to DeFi can help us in earning native tokens and protocol fees. This way we can also have a say in the protocol's governance and can also vote on key decisions.
Mom: Is this all a scam?
Me: No, DeFi is not a scam but there are some risks associated with it.
- DeFi with higher APY and less established liquidity pools are to be thoroughly studied before making an investment.
- It is not backed by any government so funds are not insured