It all started with the cryptocurrency boom in recent years, but blockchain technology is about far more than investing in digital money. A slew of new crypto projects has popped up, trying to capitalize on what has become known as the "decentralized finance" movement, or DeFi.
Does DeFi put your traditional money and investments at risk? Probably not. But it's nonetheless an important technology that could revolutionize financial markets and services in the decades ahead. Here's what it means for you personally.
What is DeFi?
In simple terms, DeFi refers to a digital financial exchange without a middleman. By using blockchain technology (a software-based ledger system distributed among owners of a token or digital coin based on its blockchain), two or more parties can execute a business transaction without the involvement of a bank or financial institution. When using cryptocurrencies to complete an exchange of value, the transaction is completed with no fiat currency issued and distributed by a federally governed central bank.
So what's the big deal? Various parties involved in DeFi have their reasons for using it. Some have grown weary of the financial system controlled by governments and are looking for ways to disrupt the status quo. Others see a more efficient, affordable financial system that works better for the digital economy, and that removes often slow and costly intermediaries (every party that touches money or is involved in a transaction gets paid, somehow). And given the massive and still-growing size of the digital payments industry (trillions of dollars change hands every year), other DeFi projects are simply just trying to get in on the action.
Whatever the reason, numerous DeFi projects have popped up in recent years. Some only aim to cash in on the cryptocurrency boom and have limited merits, but others are building actual financial services (like payments, loans, and other banking products) built on a blockchain network like Bitcoin or Ethereum (ETH 0.25%). Ethereum is a particularly popular platform for DeFi services, commanding a 66% share of the current DeFi market as measured by the total value invested in these projects. However, it's still early days for the DeFi movement, so a complete upheaval in the global financial framework isn't going to happen anytime soon.
Getting started on your DeFi journey
But what does DeFi mean for your investments? A basic tenet of investing is accepting that the economy and business world are constantly changing, and DeFi's most immediate effects could be on companies in the greater financial services space. Many of these incumbent firms, like Visa, Mastercard, and PayPal, are already experimenting with blockchain technology in some way to stay in step with the times.
However, the crypto and blockchain world are evolving quickly, and some companies are pushing for change sooner rather than later. Mixing in some of these would-be disruptor stocks into your investment portfolio can help future-proof your money. Block (formerly Square), Meta Platforms (formerly Facebook), and Coinbase Global (formerly Coinbase) are just a few ways to bet on the future of blockchain and financial services.
Then there's investing in crypto directly, which has paid off handsomely for some in recent years. Plus, owning some cryptos that use the proof-of-stake concept to verify transactions (like Ethereum) grant the owner the ability to participate directly in DeFi projects by staking (the process of computing transactions) and earning rewards for doing so (a type of passive income akin to earning a dividend from a stock). The rewards payout for some cryptos can be lucrative, but remember another key tenet of investing: More reward means more risk, or uncertainty of future value of your investment.
DeFi is an exciting new front in financial technology, one that could reshape financial services and markets. But this movement will play out over a long period of time, likely decades, so your money and investments are at imminent risk. However, there could be a big payoff if DeFi projects start to disrupt the status quo. Take a measured approach to investing in DeFi, and don't try to chase fleeting fads and get-rich-quick schemes.