Understanding Crypto and DeFi

March 26, 2022

Understanding the world of cryptocurrency and decentralized finance (DeFi) can be daunting for many. To make sense of this complex domain, let’s use familiar analogies and additional examples to break down the key concepts.

The Stock Market Analogy in Crypto

Imagine the crypto world as similar to the stock market. Just as a company’s stock value increases with its popularity and usage, so does the value of a cryptocurrency. For example, Bitcoin’s value rises as more people use it, akin to a high-demand stock. However, Bitcoin primarily functions as a digital currency, similar to a stock representing a currency’s value rather than a company’s performance.

Ethereum: Beyond a Currency

Ethereum, in contrast, is not just a currency but a platform for building blockchain applications. It’s like a technology provider whose stock value increases as more services are developed and utilized on its platform. For instance, the creation of popular DeFi applications like Uniswap or lending platforms on Ethereum boosts the demand for ETH, mirroring how a tech company’s value increases with the success of its products.

The Concept of Gas Fees

Using applications on Ethereum incurs “gas fees,” which are paid in ETH. These fees are analogous to transaction fees in traditional services. They’re necessary for executing operations and maintaining the network’s health, much like how service fees in traditional finance cover operational costs.

Tokens as Company Stocks

Each token or coin in the crypto world can be likened to a company’s stock. If you develop an application on the Ethereum network and issue a token for it, the token’s value will likely increase with your application’s popularity. It’s akin to how an innovative new product can boost a company’s stock value. Additionally, one can draw parallels between the concept of an IPO and the issuing of a token. When a new DeFi company launches a token, it’s called an Initial Coin Offering (ICO). This act is similar to launching a new stock, but with much less regulation because of DeFi’s decentralized nature. Due to this, anyone can create a cryptocurrency and launch it in an ICO.

Network Effects on Token Value

The network on which the application is built also gains value. For example, building a new NFT marketplace on the Binance Smart Chain would increase the demand for BNB, Binance’s native token, as it’s needed for transaction fees. This is similar to how a successful app on iOS increases Apple’s value due to the ecosystem’s interconnected nature.

Bitcoin: The Standalone Pioneer

Bitcoin stands apart as it doesn’t back a company or a platform. Its value is driven by its first-mover advantage status and its use in transactions, similar to a currency rather than a stock. Its role as the first cryptocurrency has made it a standard entry point into the crypto world.

Conclusion: Bridging Crypto with Familiar Concepts

In summary, this post aims to demystify the world of cryptocurrency and DeFi by drawing parallels with well-known financial concepts like the stock market, company stocks, and IPOs. By understanding how familiar mechanisms like stock value appreciation and company fundraising translate into the crypto domain – through examples like Bitcoin, Ethereum, and ICOs – we can better grasp the fundamentals of this innovative financial landscape.

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Written by Samarth, a builder, problem-solver, and amateur gymnast.