The Importance of Understanding the Blockchain and Smart Contracts Operation for DeFi Investing
Understanding smart contracts and DeFi in general is like being able to drive. If you don’t know how an engine works you won’t be able to figure out how to get the most out of your machine. But this does not mean that you need to become an engineer in order to drive a car. Similarly, to successfully invest in DeFi it is not necessary to know all the details of smart contract technology. However, having a basic understanding of how decentralization works will help you make informed decisions and guard against unpleasant surprises.
So why not give everyone a chance to invest in DeFi without understanding the technical details, even to hamsters?
This is how DeFi works and in this it is very different from the banking system we are used to.
DeFi (Decentralized Finance) is an ecosystem of financial instruments based on blockchain technology that does not require the participation of intermediaries in the form of banks and financial institutions. This allows users to access lending, swapping, trading and holding assets without having to go through complex verification procedures.
However, it is important to understand that decentralization has its risks as in any other investment area. Some projects turn out to be fraudulent as a result of which investors are exposed to risks. Therefore, before investing in DeFi it is necessary to study the project, its team and the possible consequences of wrong decisions.
This is how a smart contract works and there is nothing complicated about it.
When you go to a cafe to buy an Americano you know what you have to do – order coffee from the barista and he or she will prepare a drink for you. And you do not need to know how to do it. A smart contract is a kind of “barista”. You tell it the terms and it automatically does what you ask without using an intermediary. Thus you can trust the technology and know that the order will be executed correctly and safely.
But let’s get back to the question of whether you need to understand how blockchain and smart contracts work in order to successfully invest in DeFi. Actually no, not necessarily. The most important thing is to understand how the particular product works in which you are investing. For example if you want to invest in liquidity on the Uniswap platform then it is important to know what it means and how you will get profit. But it is not necessary to understand how each blockchain works or how smart contracts are created.
There are reviews of decentralized projects that give the user a general idea of which one is operating and what functions it performs. There are also decentralized exchanges (DEXs) where tokens are sold and bought without registration and identity verification. These exchanges can sometimes be a little daunting for beginners but they usually have a logical interface and plenty of tutorials.
In addition there are decentralized funds (DAOs) that allow users to jointly invest in DeFi projects. In this case you can join them and make decisions about where to invest together with other members without worrying about technical details.
As you see it is not always necessary to know the technical details for investing in DeFi. But, of course, understanding the basic principles of decentralization will help increase efficiency.
Shares or DeFi?
There are similarities between investing in DeFi and buying shares. In both cases you need to have enough information to make the right decisions. However, in a decentralized system there are some features that may be difficult for beginners to understand.
Unlike stocks where profitability depends on the success of the company profitability in DeFi can be driven by many factors including market dynamics and the efficiency with which financial instruments are used. Moreover, the growth of another asset that you do not have in your portfolio can also provoke an increase in the price of your project.
Some investors successfully invest in DeFi without understanding all the technical details due to the fact that they follow the market trends and study projects.
However, there is a small reservation – in the market there is one who loses and there is one who increases capital. Therefore, it is important to invest only the part that you can afford to lose. And it doesn’t have to be your last money.
What About Decentralization? Does It Really Exist?
Anyone who thinks that blockchain and the crypto industry will remain in the shadows and support decentralization is wrong. Everything is under control in the world especially the money supply.
Until recently the crypto world remained incomprehensible to many everything was possible in it and no one knew what would happen tomorrow. However, when the hype around “easy” money rose the authorities began to pay more and more attention to this problem. The first to be at risk were exchanges that were forced to introduce KYC (“know your customer”) under the threat of sanctions. But not all giants of the crypto market have given up. There are few small but still free platforms left. No one knows how much more time they can resist.
The main idea that the cryptocurrency differs from the rest by decentralization is just a soap bubble that can burst at any moment. Nothing prevents your data from declassifying especially if you keep cryptocurrency on exchanges. Any law, any rules can be rewritten and there is nothing you can do about it. And if you don’t like something you will be asked to leave.
Everyone is slowly implementing KYC into their terms. And it is possible that the holders that keep crypto on “hot” wallets can become the next ones.
Here is just a fresh example of how the system buckles the big business. Starting May 8, Bybit introduces strict controls on its users. Now in order to use the services of the platform everyone must pass a Know Your Customer (KYC) identity verification.
Anyway traders, don’t be sad – even despite it you will still be able to freely withdraw your cryptocurrencies regardless of whether you passed the KYC verification or not. This is just the moment when you can see that even in the world of cryptocurrencies where decentralization has become a kind of symbol of freedom bureaucratic procedures cannot be avoided. After all, someone must monitor all money flows in order to prevent financial fraud and illegal actions. However, even with control your cryptocurrencies remain safe at the finish line and you can freely dispose of them.
Binance has not become exception either. As we know, over the years of pressure from regulators the crypto exchange has started requiring KYC for all new users. But what will happen to the rest who don’t have resources like Binance? I think that if they also adapt to the new rules they risk being forgotten. After all, it is difficult to compete with such giants when you do not have an ace up your sleeve which is the refusal of verification, isn’t it?
Where Should “Hamsters” Go?
A few more large exchanges remained out of sight of regulators – these are KuCoin, Mex, Huobi and OKX. But isn’t it too optimistic to think that they will remain intact? Who knows, maybe tomorrow we will hear that they are also introducing KYC. And then we will have to say goodbye to the carefree days when we could trade without providing personal data. Or soon these exchanges will be closed by regulators for non-compliance with KYC, who knows?
Whatever one may say but there has been a theory of the world conspiracy, it is and it will be. And the world government will do its best to reveal any schemes especially when it comes to finances.
Despite all these facts the cryptocurrencies and blockchain in particular still attract many investors due to their simplicity and freedom. Why? Because you do not need to comply with the minimum account balance when transferring, you will not be charged additional interest for the transfer, a transaction of any amount will be completed in a matter of minutes and no one will ask where the n-amount of money came from.
DeFi is like a convenient and reliable coffee vending machine in which you just need to press a button so that all complex operations are carried out without your participation and even more so without intermediaries. There are no restrictions, anyone can become an investor. Thanks to it, DeFi brings together those who have access to the best financial instruments and those who do not have it – the latter can just be considered as the notorious “hamsters”.
With the open source code that powers DeFi services they can be combined and modified in an infinite number of ways. For example, the program will be able to automatically reallocate investments into different credit pools based on their returns if you program it that way. Thus, the innovation inherent in e-commerce and social media can become the norm in traditional financial services.
Kevin Werbach. Professor of Legal Studies and Business Ethics, University of Pennsylvania
“At the recent market peak in May 2021, over $80 billion worth of cryptocurrencies were locked in DeFi contracts, up from less than $1 billion a year earlier. The total value of the market was $69 billion as of Aug. 3, 2021.
That’s just a drop in the bucket of the $20 trillion global financial sector, which suggests there is plenty of room for more growth.
At the moment, users are mostly experienced cryptocurrency traders, not yet the novice investors who have flocked to platforms like Robinhood. Even among cryptocurrency holders, just 1% have tried DeFi.”
Sandeepa Kaur, Simarjeet Singh, Sanjay Gupta. Financial analysts, crypto industry experts
“DeFi protocols have also raised serious concerns for regulators. Due to the fact that most DeFi protocols are unregulated, DeFi has become a magnet for money laundering and fraud (Vereckey 2021). Being unregulated, DeFi protocols also lack consumer safeguards; According to a report by Elliptic research, consumers lost $10 billion in 2021 due to DeFi scams. In addition to this, the collection of taxes is also a major concern in DeFi protocols. Since most of the protocols are built on pseudonymous and permissionless ledgers, traceability of DeFi transactions is a difficult task. According to one estimate by Barclays, internal revenue services may miss a revenue of $50 billion due to the pseudonymous nature of DeFi protocols. Further, developers of most DeFi protocols often lack the required financial expertise and knowledge (Montaz 2022). In short, all these hurdles are a significant challenge in the mainstream adoption of DeFi protocols.”
Lado Okhotnikov, CEO of Meta-force.space, former CEO of Forsage.io
“DeFi is becoming a new stage in the development of financial services which has already opened access to ordinary people to financial instruments and services that were previously only allowed to the rich.
However, a decentralized system is not without risks like any innovation. Blockchain technology and the smart contracts on which it is based are prone to bugs and malicious attacks. Therefore, understanding the technical aspects and risks is essential for successful DeFi investing.
If you draw an analogy with driving then having at least the basic knowledge of how DeFi works you can quickly and safely get to your destination. Similarly, understanding smart contracts and risks in DeFi will help you reach your financial goals quickly and safely.
In fact, decentralization has opened up a huge pool of innovation in the financial industry and is changing conventional financial services. However, in order to successfully use this technology it is important to be aware of the technical nuances and risks associated with it.
At the same time there is nothing to worry about if you are still not completely familiar with DeFi technology. This will not prevent you from investing in cryptocurrency although it will be more difficult to do due to the inability to analyze certain projects.”