#defi #finance #bitcoin #crypto
Category
😹
FunTranscript
00:00What is DeFi? Well, it stands for Decentralized Finance. In the past, we have always used
00:06Centralized Finance, which is where there's a central authority that controls the flow of
00:11money. The government and the banks control it. They don't really say they do, but they do. They
00:16can print more of it if they want to. They can stop you from borrowing it if they don't want
00:20you to. They can even stop you from having a bank account. If they wanted to, at any time,
00:25they could have your money. They have your money, so they could change it, and you really couldn't
00:30argue against it. I mean, you could, but how would you prove it? You gave your money to them. It was
00:34based on trust. Also, if you're running a business, they limit what you can do. For example, right now,
00:40if you have a little magical tree business that may be for medicinal purposes, they can tell you
00:45not to bring in any of that money from the business to the bank, which seriously limits you. It means
00:50you can't deposit it or invest it or even use them to keep it safe. One more thing,
00:55traditional finance is quite expensive. Payday loans go up to 500%, credit cards can average 25%,
01:01and even personal loans can cost you 18% of your value. These are really high rates, but you pay
01:06them if you need to, because that's what you got. The alternative is decentralized finance, where
01:12there are no banks. Instead, there are pieces of code that run and act as a bank. They're open to
01:17anyone. They don't require you to trust them because they're literally a piece of code running a
01:21program. If you wanted to, you could read through it and verify that it's not going to
01:25scam you. They are also censorship resistant. And lastly, they are much, much cheaper than
01:30traditional centralized finance. Decentralized finance is built on three main things,
01:35cryptography, the blockchain technology, and smart contracts. If you don't know what these
01:40are, we highly recommend that you check out our other videos on these topics, where we break
01:45these topics down so simply using stories and examples and analogies that even your grandfather
01:50could understand them. Now, this is going to be a bit of a longer video, but it's a very broad
01:54and growing topic. Anyways, assuming you understand the cryptography, the blockchain,
01:59and how smart contracts work, let's dive into the five pillars of decentralized finance.
02:04Number one, stable coins. So first off, we need to understand the bridge of decentralized finance
02:10to centralized finance. And that is cryptocurrency that is matched to a real world asset. For example,
02:16DAI, Tether, and USD coin are all what we call stable coins. This is because their price is tied
02:23to the United States dollar. Think about it like this. When you buy one for $1, a new USD coin is
02:29minted. When you withdraw one, a USD coin is burned. So the coin is always worth one United States dollar.
02:36Now, the purpose of this is to have a reliable way to buy and sell certain coins without having to
02:40buy and sell them. Instead, we can just trade them. Here's an example of why this might be beneficial.
02:45Let's say you bought one Ethereum at $500. Well, now it's $1,000 and you want to sell because you
02:51think it's high. You want to take your profits. Without stable coins, you have to sell your
02:56Ethereum at a centralized exchange like Coinbase or Binance. And in return, they will give you
03:01some United States dollars for it. Now, of course, they're going to take a cut of that transaction
03:05because they want a fee and they're going to take it. Also, the IRS makes you pay tax on any gains
03:10that you make from trading or selling. Coinbase and Gemini will be snitching that you made it so
03:14you can't really get around it. The next step would be to wait for Coinbase or Binance to give
03:19them to your bank and then withdraw them from your bank because you don't really want the bank
03:23controlling your money. Well, a month later, Ethereum drops to $250 and you want to buy
03:27more. So you deposit your $1,000 back into Coinbase, wait a few days for the transaction
03:32to clear because you have to wait and then buy for Ethereum and hold them. Well, Ethereum rises
03:37again to $500 and you decide to sell. So you sell them at your centralized exchange.
03:42You bite the fee and then you wait a few more days for it to hit your bank account.
03:45See, in this example, there's a lot of fees, there's taxes, and there's waiting.
03:49Now, let's say we utilized a stable coin like USDC. You bought one Ethereum at $500 and it
03:55raises to $1,000. Instead of going through all that headache, you trade your one Ethereum
03:59for $1,000 USDC and you just hold it. A month later, similar to the previous example,
04:04it drops to $250 and you trade your $1,000 USDC for $4,000. Then it raises to $500.
04:10And here's the beneficial part. Within five minutes, you sell your four Ethereum for $2,000.
04:17The fees were less than 1% because you used what we call a decentralized exchange to trade,
04:22which is something we'll explain later. But because of it, you were able to trade almost
04:26instantly. Plus, the USDC was secure and you trusted it because it's just code. It doesn't
04:31change. Unlike Coinbase or Binance or Gemini, which are controlled by the government and more
04:36importantly, people. They have been hacked before. Anyways, we are getting off topic.
04:41So that's the purpose of stable coin. You can be in the crypto sphere without actually using
04:45your government owned bank. Now, in a lot of places, we take banks for granted like in the US,
04:50but some countries are really limiting in how much money you can move around or what currency
04:55you can buy them from. In fact, in the United States, every transaction over $10,000 has to be
05:00vetted and approved by a bank. Meanwhile, using a stable coin like USDC, you can move $10 million
05:06from one address to another without anyone blinking an eye for like a $5 fee. You could never do that
05:12with United States dollars. Number two, borrowing and lending. So another important pillar of
05:18decentralized finance is lending and borrowing. In fact, a huge part of our current financial
05:22situation in the world is based on lending and borrowing money. So it would make sense that the
05:27blockchain could do it better. One of the reasons we can reliably lend and borrow with banks is
05:31because we usually put something down like 20% collateral so that if we never pay back the full
05:36loan, our government can come after us and throw us in jail or make us pay that money. In short,
05:41there are legal consequences for not paying a loan back. Well, with crypto, this is a problem
05:46because one of the pros of crypto is anonymity. You could put 20% down and run away with the rest of
05:51the loan never to be seen again. So we have to find a way to solve this. In fact, with the use of
05:56smart contracts, we can actually allow others to use our funds while still keeping custody of them.
06:02So let me go through a little example. Person A wants to earn interest on his coins while person
06:06B wants to borrow some coins. So person A goes to compound or Aave, which are two platforms that
06:11allow crypto borrowing and lending. And person A deposits his coins into a smart contract. If you
06:16don't know already, smart contracts are just code that run a particular function. In turn, what he gets
06:20are called C tokens or A tokens that are a representation of his original coin plus interest.
06:27Whenever he wants to, he can just turn his A tokens or C tokens into that smart contract that
06:32was created by compound or Aave, and they spit out his original deposit plus interest. Now the smart
06:37contract is created this way so that there's no human being that has to do the calculation or have
06:42to do the transaction. It's all automatic by code. So that solves person A wanting to earn interest by
06:48lending in a traditional way. In the borrowing portion, person B must do something called
06:53over collateralize his loan. This means if he wants to borrow $100, he must put up $120. So that way,
07:00if he runs away and never pays back his loan, the smart contract is written in a way that it can pay
07:04back person A their coins plus interest. Now at this point in time, you might be asking, what's the
07:09point of taking a loan if you already have the money? Well, you're probably thinking in United States
07:14dollars. Say you have 10 Ethereum worth $1,000 because they're each worth $100, but you don't
07:20want to sell them because you greatly believe in the Ethereum project. So you put them up as
07:24collateral and borrow $800 worth of Tether, which is a stable coined pegged to the United States
07:29dollar. So you trade that $800 around, you make some money, you lose some money, you make some more
07:34money, and now it's time to pay back your loan. So you have $850 in Tether and you pay back the
07:39original $800 loan to get back your 10 Ethereum. Well, in this little example, you made $50 from
07:45the little trades that you did and you got lucky, but it has also been a few months and Ethereum like
07:50it has done in the past few months exploded. And now they're worth $150 each. So now you have 10
07:56Ethereum at $150 each. So now you control $1,500 plus the $50 you made trading. Basically, if you
08:04believe in Ethereum and you have it, but don't want to sell it and you want to use the value of
08:09it, you can take a loan out on it, hoping that it will be worth more whenever you cash it out.
08:13However, if you traded, you lost some money, you gained some money, and then you lost some money,
08:17and maybe you ended up with $750 Tether, you would have two options. Option A is to front the
08:23extra $50 to pay back the full loan, the $800 to get back all of your collateral. And option B is to
08:29just keep your $750 and lose your 10 Ethereum, which could be worth a lot. Now this might be
08:34information overload, but real quick, there is a second type of loan in crypto called a flash
08:39loan, which is a loan that lasts for like 10 seconds. If you could buy Ethereum for $10 on
08:44Coinbase and then sell it for $11 on Gemini, theoretically, you can make a dollar every
08:49time you did that. And so you can use what we call is a flash loan to literally borrow millions of
08:54dollars. You don't have to put any money down. You just write a flash loan to borrow $10 million,
08:59you tell it to go buy Ethereum for $10, and then immediately sell it for $11, and then you pay
09:04back the original loan $10 million in all one small little smart contract that gets run in 10
09:10seconds. Essentially, you made a million dollars minus the fees that you had to pay for borrowing.
09:14But these fees are small because the lender knew that you would have to pay them back and that it was
09:19for a very short period of time. Now this is a more advanced technique, but you could never perform
09:23this type of arbitrage in traditional finance. Number three, decentralized exchanges. Okay, so I have a
09:29friend who traveled to London a few years ago from the United States. Now, of course, in London,
09:33the standard currency is Euros, while over here in the US, it's dollars. So naturally, he had to visit
09:39a foreign exchange booth and trade out his dollars for Euros. Unfortunately for him, the fee was like
09:4415%. So he immediately lost 15% of his money because that's what foreign exchange traders do.
09:51Tourists don't know any better, and they need local money. So what they do is they take advantage of
09:55these people. Well, when it comes to decentralized finance, instead of a foreign exchange trader,
10:00we have what is called a decentralized exchange where you can exchange your coins and tokens for
10:05other coins and tokens. Now, the fees are usually very small, like less than half of a percent,
10:10which is a great benefit for anyone who regularly wants to trade their crypto assets.
10:14Most popular decentralized exchanges, or DEXs, work in a manner where investors pool their money
10:19together and then traders can trade that money. The fee of every trade that I mentioned earlier goes back
10:24to those investors. And it's all written in code, so it doesn't change. A government can't step in
10:29and say, you can't buy Bitcoin anymore. The fees and the percentages that you change are locked too.
10:34They're written in code, so they don't change and they can't raise to crazy prices like 15%.
10:39Decentralized exchanges open the world up to a whole new variety of tokens and coins. For example,
10:44Coinbase, the first centralized exchange to go public, only allows you to buy and sell 32
10:49cryptocurrencies at the moment. Since they are regulated by the government and have to
10:53abide by certain regulations, they very closely analyze each coin before adding it. The most
10:58popular decentralized exchange, which is called Uniswap, literally has hundreds, maybe even
11:03thousands of tokens that you can trade. And they aren't regulated by anyone. That's the
11:08decentralized part. There are billions of dollars locked up in these liquidity pools so traders can
11:12trade, but nobody can control these billions of dollars. They're just following a program that
11:17someone wrote. In fact, only investors can be the ones to pull out their money out of the pool.
11:21But if they did that, the lending rates would rise. And so new investors would come along
11:25and put their money in. So like I said earlier, the code can't be changed either. It's what we
11:29call immutable. So in the crypto space, we like to say that the code is the law. The government
11:34doesn't control it. The code does. And everyone has access to the code and it doesn't change.
11:39Uniswap is one of the major exchanges on the Ethereum network, and it has billions of dollars in
11:44its pools. PancakeSwap is another exchange on the Binance Smart Chain network that also has a few
11:49billion dollars of liquidity. Number four, insurance. Insurance is really easy to explain.
11:55For example, with car insurance, you pay $100 a month to protect your new Tesla. However,
12:00one day while using the autopilot feature, another car causes the autopilot to glitch and you drive
12:05into a ditch. Unharmed though, but you totally wrecked the car. Well, since you paid insurance,
12:10the insurance company pays you what the Tesla was worth so that you can go buy a new one.
12:14They use statistics to predict how many of their drivers will crash their cars,
12:17and then use this data to predict how much they would have to pay each year to determine what
12:21the monthly price of the insurance should be, which is also called the premium. Well,
12:25with decentralized finance, the insurance company can be code. So let's go over an example. Let's
12:30say a farmer wants to buy crop insurance. So if his crops die, he still has income for planting them
12:36and taking that risk. We could write a piece of code on the Ethereum network that says,
12:39if there's any days this summer that are 90 degrees Fahrenheit or hotter, four days in a row,
12:44pay out Farmer Joe $100,000. However, to start this contract, he has to pay $2,000. So Farmer Joe
12:51can buy his crop insurance through what is called a smart contract, which is just code that sees if
12:56the conditions are met to pay him. So at this point in time, you might have two questions.
13:00How does the code know if it's 95 degrees Fahrenheit? And where does the $100,000 come from?
13:05Well, to connect the real world to the blockchain, we have to use something called oracles,
13:10which are trusted sources that become a bridge between the real world and the crypto world.
13:15We can create an oracle in our city that reads the temperature and is verified by a few people
13:19to make sure that it can't be frauded. Then the smart contract can reliably use it as a data source
13:24to decide if insurance requirements are met or not. Secondly, the $100,000 comes from other people
13:29buying insurance that bought the premiums, but maybe they didn't get paid out because the
13:33requirements were not met. Just like an insurance company makes profit, people who provide liquidity
13:38to any decentralized finance platform may be incentivized with an interest rate to earn on
13:42their deposit. In other words, some of the $100,000 may come from investors who earn money by lending
13:48their money. Lastly, we have number five, which is margin trading. So margin trading is a whole new
13:53beast. Let me explain margin trading in the traditional world real quick, and then I'll explain it in the
13:58decentralized world. So you want to buy the Apple stock, and right now it is $100. So essentially
14:03what margin is, is it is a loan that will automatically sell your stock if the stock goes
14:09below your down payment. So to buy a $100 stock, you need a $100 loan. And the bank agrees to give
14:15you that $100 loan if you can give them a $20 down payment and a small fee of 5% a year. So here's two
14:21scenarios that could happen. The stock goes from $100 to $150. You have paper hands, so you decide to sell
14:28the stock and you get $150. You pay back $80 of your loan because the bank already had your original
14:34$20 as a down payment, and you keep the rest, which is a profit of $70. So essentially you made $70 by
14:40only spending $20. This means that you more than tripled your money, even though the stock only went up
14:4550%. This is the power of margin. You use it when you think something is going to increase in value to
14:51multiply your own money. Now, let's take a look at another situation. This is the second scenario, and it's if
14:57the stock drops to $50. Well, with margin, you actually have to sell as soon as the value of
15:02what you bought can't pay back your loan. So the stock starts out at $100, then it starts dropping,
15:07$90, $85. And then as soon as it hits $80, boom, the bank forces you to sell your one stock of Apple
15:13at $80 so that you can pay them back those $80 that you borrowed. So the $80 you made from selling
15:19the stock plus the $20 that you gave them as a down payment equalizes the loan. And now the bank has
15:24their original $100 they originally gave you. So you're free and clear. You've paid your loan
15:28back, but you didn't profit anything. In fact, you lost your original $20 that you put up as
15:34down payment. In centralized finance, to trade on margin, you usually need to be able to prove who
15:39you are, along with have a minimum of a few thousand dollars to even have access to margin
15:44trading. The fees are also much higher, much higher than 5%. In decentralized finance, margin trading
15:50can be a lot quicker, open to anyone in the world with money, and a lot safer as well.
15:55So wrapping this video up, we have covered five big pillars in decentralized finance.
15:59Stablecoins, lending and borrowing, decentralized exchanges, insurance, and margin. Hopefully now
16:05you can see the value add of decentralized finance, and why so many investors are piling billions of
16:10dollars into this new technology. If you've learned anything from this video, we encourage you to
16:15hit that like button to reward our hard work, and consider subscribing for more great crypto
16:19explainer videos such as this one. Thank you guys so much for watching, and we hope to see you in the
16:24next one.