Decentralized Finance (DeFi)
If you’re someone interested in blockchain technology and cryptocurrencies, then you have probably heard about Decentralized Finance, also known as Open Finance or DeFi.
It’s a part of blockchain technology and aims at making a financial system that’s independent, decentralized, and reliable & transparent at the same time. A global alternative to basically every financial service people are using today. Imagine loans, trading, savings and more, available to anyone with a smartphone and internet.
What is Decentralized Finance (DeFi)?
DeFi is a financial ecosystem built on blockchain technology. Unlike the existing financial systems which are centralized and regulated by monetary authorities, decentralized financials or DeFi refers to an open-source and accessible-to-everyone financial system. The key differentiator here is the absence of a regulatory authority.
In decentralized financials or DeFi, each user has complete control over its assets and transactions. A DeFi ecosystem can be accessed through a decentralized peer to peer application or commonly known as dApp.
Decentralized Finance is a reality thanks to blockchains supporting smart contracts. Smart contracts can be described as applications or programs running on a blockchain that are executed automatically when prescribed conditions are met. With smart contracts, developers are now able to build a far more extensive range of functionalities than just sending and receiving cryptocurrencies. These applications are called decentralized apps, better known as dApps. The most famous blockchain that is supporting dApps is Ethereum. When dApps offer a financial service like mentioned before we categorize this as DeFi.
Differences between DeFi apps and regular financial service providers
There are some critical differences between these DeFi apps and regular financial service providers. The most important difference between these services is the ease of access. DeFi apps are much easier to access than central financial services. This is because dApps are global, and wherever you are, you will always have access to the same services and networks. Although local regulations may have an influence on the core DeFi apps are available to anyone with an internet connection.
DeFi apps are also easier to access because you don’t need permissions to create and participate. Anyone is able to develop and launch a DeFi app, and anyone is able to use that app. Users do not necessarily interact with the party behind the dApp but directly with the code.
At their core, operations of Decentralized Finance are not managed by an institution. Instead, the rules are written in smart contracts. When a smart contract has been launched on the blockchain, the DeFi dApp can operate with minimal to no human help.
The code of DeFi apps is open-source; transparent for anyone to audit. It is resulting in a new sort of relationship between the app and its user. Users are now able to understand and check functionalities.
Decentralized Apps also have a better user experience. Not feeling the interface of a particular dApp? No problem. You can use a third-party interface or build your own. Smart contracts are like an open API that anyone can build an app for. This also makes it possible that new DeFi applications can be built or composed by connecting other DeFi products like a puzzle.
What are the benefits of DeFi?
The conventional financial services are centralized, limited, and inaccessible to many people. Third-party institutions act as regulatory authorities to regulate the conventional financial system, which certainly puts limitations on the system. While decentralized financials DeFi solely relies on programming or code where no intermediary authority has to regulate the system.
In decentralized financials, smart contracts are created that automatically document whatever transaction is made. DeFi allows anyone from any part of the world to participate in a decentralized financial ecosystem using dApps. It is truly decentralized nature allows anyone sitting in any part of the world to participate regardless of his/her social status, meaning it promotes censorship resistance and even allows those to participate not having a bank account.
Cost is another huge benefit as it doesn’t cost much to use this financial system. Anyone can use the financial services it offers without spending too much money.
Decentralized financials allow censorship resistance, frictionless financial services, privacy, and high-level transparency. The data is spread across the whole network. As the network keeps increasing and nodes keep adding to the network, the data security and privacy keeps getting stronger. The existing financial system is fragile and outdated, making it less safe.
How does DeFi work?
One of the most used applications of DeFi is lending. This is done by locking the holdings in your wallet in a DeFi smart contract like the ones of Compound, Aave or Maker. Once your funds are locked up in the smart contracts this basically means that your funds are available for others to lend. As a reward you will get paid interest on your locked funds. The interest is based on the supply and demand of the particular asset you are offering for lending.
is currently the most popular network for DeFi applications and one of the most popular wallet apps for DeFi solutions is Argent. With Argent you have access to multiple DeFi solutions allowing you to earn interest. If you prefer investing directly into one of the DeFi projects then you could explore Compound
DeFi can be used in a lot of situations
Decentralized financials aren’t just about creating peer to peer credit marketplaces and providing liquidity solutions. Its purpose is to develop a decentralized system that allows bitcoin
lending, investment, trading, exchange, insurance management, and much more.
Currently, the whole system isn’t decentralized. Some parts are hybrid, and some are completely decentralized. Some services of DeFi like BlockFi started with a hybrid solution, meaning it involved both a centralized and decentralized approach. As it’ll develop further, we’ll see a completely decentralized financial system. The ultimate objective is to develop it into a completely decentralized financial system, which will be open to everyone without having the need to regulate it by anyone.
DeFi still needs a lot of improvement before it can be used in almost every financial situation. Though we are all sure this moment will come in the near future, as developers are working hard to make it happen.
Some examples of DeFi use cases
There are several ways DeFi could be used in our daily life. These use cases show how efficient and strong DeFi can be if we adapt it to situations that now are managed by central systems.
Decentralized Financials (DeFi) puts you in complete control of your cryptocurrencies. DeFi protocols allow you to use your funds the way you want. It all happens by using decentralized applications or dApps. Whether you want to purchase something, sell something, or transfer your funds, dApps enable you to perform any function you want.
You are the custodian of your data including your seed phrase, password, and private keys. This data is stored on a platform that can be accessed anytime you want.
Data and analytics
Blockchain-based decentralized financials enable a high level of transparency around financial services and network activity. This brings in a lot of data and analytics to play with, which can be put to great use by discovering insights from it. Moreover, it lets you achieve optimal risk assessment and management.
Given the advantage of data and analytics, several useful tools are developed that enable a better understanding of the technology.
Insurance providers can use DeFi by making use of smart contracts. They can store the conditions of their policy in smart contracts. This makes it very trustworthy for both the insurance company as the customer. Actions are only performed when conditions are met, otherwise, nothing happens.
As you know by now, DeFi is very useful, has a lot of benefits and could completely change the way we are using financial systems. After gambling and gaming, DeFi is now one of the fastest-growing applications of crypto. Being early days, users should always do research when deciding to use services or buy products. Like any computer code, smart contracts can be vulnerable to both unintended programming mistakes and malicious hacks.