Introduction to Cryptocurrencies and DeFi

The decentralized economy is a set of tools that are gradually being integrated into society, like cryptocurrencies, and are beginning to replace the traditional banking system, based on central banks and governments, which has been in place since the Bretton Woods Agreements in 1944.

With blockchain, information is not stored on a single server, but is spread across numerous nodes around the world. The advantages of this system in the financial industry is that it avoids depending on third parties both to store value (assets) and to transfer it. Until now, these operations could only be carried out through banks.

Exchanges

The opposite concept to DeFi is the current-centralized model, known as CeFi.

CeFi (Centralized Integrated Fiat Exchanges) is a cryptocurrency exchange platform that, unlike DeFi, is centralized, which means that a central entity controls the management of transactions and user accounts. CeFi’s allow users to buy and sell cryptocurrencies with fiat currencies (traditional currencies issued by a government, such as the US dollar, euro, among others). In addition, they are usually regulated and require identity verification to comply with anti-money laundering and terrorism prevention laws.

To start using DeFi with our fiat money, we first need to go through an intermediary platform (exchange) that allows us to exchange our money for tokens from a DeFi platform, since in DeFi there is no fiat money that we use in our day-to-day life. The platforms for exchanging money for tokens do not have to be decentralized, but they are one of the gateways to access decentralized networks.

Wallets & Cryptocurrencies

In order to use decentralized platforms, tools called wallets are required.

Wallets are digital tools that allow you to store, send and receive different cryptocurrencies securely. They can be installed directly on the cell phone or on the computer browser, one of the most popular being Metamask (tutorial with Goerli test network). To function, wallets generate a pair of keys, one public and one private, which are used to perform transactions on the blockchain. The public key is shared with other users and is used to receive funds, while the private key is kept secret and is used to authorize and confirm transactions. There are different types of wallets, such as software wallets, hardware wallets and mobile wallets, and some of them support several cryptocurrencies, while others only support one.

Stablecoins

Stablecoins are specific types of cryptocurrencies that seek to stabilize their value by being backed by a stable asset, such as the dollar, euro, or gold. Because of this, they become currencies with 1:1 parity, which allows them to avoid the volatility that characterizes other cryptocurrencies such as Bitcoin. This makes them an attractive option for storing value and transacting on the blockchain in a stable manner, but they have the same behaviour in the technology realm as any other cryptocurrency.

In a wallet, you could store tokens representing dollars that are stored in a bank account and be able to exchange them without intermediaries. The downside of this is that it involves trusting that the company issuing these tokens actually has those fiat currencies in a bank depository.

Banks and institutions in the world of technology and communication are very interested in the use of this type of asset.

Central Bank Digital Currency (CBDC)

In recent years, central banks and governments are developing a new system called CBDC (Central Bank Digital Currency). CBDCs are a digital form of currency issued and backed by a central bank, similar in use and operation to traditional currencies, but stored and transferred in digital format. In this way, it allows these organizations to be connected to each person’s device and to be able to program consumption behaviours based on certain objectives of the government or entity.

This is more developed in China, but in Europe has also begun to be implemented, as they seek to provide a secure and reliable way to perform digital transactions, while efficiency and transparency in the operations of central banks.

This concept is diametrically opposed to cryptocurrencies such as Bitcoin. In contrast, CBDCs are backed by the government and regulated by a central bank, which regulates where such money can and cannot be invested. Currently, several central banks are investigating the possibility of issuing their own CBDCs, but there is still no mass implementation worldwide.