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Technological innovation has provided new ways in which we manage, move and invest money. The financial industry has been transformed in recent years, and as the crypto industry continues to grow, new concepts and opportunities are surfacing.
Decentralized finance (DeFi) is an emerging and fast-growing technology sector of the crypto industry. DeFi is creating a new financial system that doesn’t rely on traditional intermediaries like banks or insurance brokers, providing more freedom and creativity.
DeFi is the ability to operate your personal or business finances without anyone’s permission. If you want to earn interest on your emergency savings, you don’t need to open a bank account. If you want to trade one investment for another, you don’t have to wait for the stock market to open. With DeFi, you are in complete control of your money, and it’s available 24/7, 365 days a year, to spend, save or invest as you see fit.
Before getting involved with DeFi, it is essential to understand the fundamentals. Learning how DeFi operates and the associated risks and rewards is a recommended first step that can be aided by obtaining a Certified Digital Asset Advisor (CDAA) designation.
How does DeFi work?
DeFi doesn’t exist on the central server of a bank; it resides on the blockchain. According to MarketsandMarkets, the blockchain technology market is expected to grow to $67.4 billion by 2026, from just $4.9 billion in 2021. Any organization with the technical skills and knowledge to do so can launch an application (referred to as a protocol), available for anyone to use.
To enjoy the benefits of DeFi, you first need a crypto wallet. Only some wallets give you access to the full universe of DeFi protocols. Custodial wallets (Coinbase, Gemini, etc.) will offer limited access to DeFi much like a bank only allows access to certain products and services.
Once your wallet is funded with cryptocurrency, you can connect it to a DeFi website and transact directly with the protocol. For example, I can deposit $10,000 directly into a lending protocol using my browser and start earning interest the second the transaction is complete.
What are the pros and cons of DeFi?
DeFi users have access to their money any time. The American investor and the co-founder and CEO of Gemini exchange, Tyler Winklevoss, articulated the potential of DeFi in a tweet just over a year ago, stating, “DeFi is not only the next frontier, it’s a level playing field.”
There are no rules to access funds and no restrictions based on your income, demographics, geographic location or financial history. Contrast this with trying to wire funds for a home closing. You have to wait for the bank to open, set an appointment and then pay a fee to access your own money. Your wire might go out the same day, but only if the bank didn’t place a 10-day hold on one of your recent deposits. With DeFi, the counterparty receives it within minutes.
One of the issues with DeFi is that new users are unable to distinguish between safe and risky protocols. Many DeFi solutions have been around for multiple years, hold over $10 billion in deposits, and are battle-tested. Users should focus on these “blue chip” solutions, but they aren’t trained to spot them.
New protocols are flashy and exciting but should only be tested by experienced users. If a DeFi solution is going to have a major issue, like a hack, it will likely happen early in its life. If the typical person doesn’t have a reliable guide to introduce them to DeFi, they may end up depositing their money with the Bear Stearns of crypto.
How can someone invest in DeFi and what are its risks and rewards?
The easiest way to invest in DeFi is to find a fiduciary with education and training in the risks and potential rewards. A great place to start is to find a Certified Digital Asset Advisor (CDAA). These professionals have their reputation on the line when providing crypto advice. Your brother-in-law who recently became a DeFi expert is only risking an invite to Thanksgiving.
I can’t imagine better financial education than losing $100 in crypto while learning how to navigate our future economy. For many of us, that future is now. As Tesla CEO and billionaire Elon Musk once said in a tweet, “Don’t defy DeFi.”
Steve Larsen, CPA, CFP® is co-founder of PlannerDAO, a cryptocurrency education community for financial planners. He is also co-founder of the Certified Digital Asset Advisor (CDAA) designation, as well as an adjunct professor of finance at Gonzaga University, where he teaches classes in cryptocurrency and financial planning. To learn more about PlannerDAO, please visit plannerdao.com.
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
