“DeFi” is an acronym that stands for “decentralized finance,” which refers to a range of financial applications in crypto or blockchain, all of which are geared towards eliminating financial intermediaries.
DeFi is inspired by blockchain technology, which is the basis of the digital currency bitcoin. It allows multiple entities to have a copy of the history of transactions and it’s not controlled by one central source. This is important as centralized systems and human gatekeepers may limit the speed and sophistication of transaction speeds while giving users less control over their money. DeFi stands out because it extends blockchain’s use beyond simple value transfer to more complicated financial use cases.
How does DeFi work
Bitcoin and other digital-native assets are different from legacy digital payment methods like PayPal and Visa in that they eliminate all middlemen from transactions. DeFi expands on the basic idea of Bitcoin and creates a digital alternative to Wall Street. However, there are no associated costs such as trading floors, office towers, or banker salaries. This could lead to more transparent, fair, and free financial markets that can be accessed by anyone with an internet connection.
The majority of decentralized finance apps are built on Ethereum, the second-largest cryptocurrency exchange in the world. It’s simpler to use Ethereum to create other types of decentralized applications than simple transactions.
Differences With Traditional Finance
Traditional finance holds your money in banks. These corporations have the overarching goal of making money. Third parties facilitate money movement between people in the financial system. Each one charges fees for their services. Let’s say, for example, you buy a pizza with your credit card. The merchant charges the acquiring bank. They then forward the details to the credit-card network.
The network charges the merchant and asks for payment from your bank. Your bank approves the charge, and the payment is sent back to the merchant by the acquiring bank. Each entity in the chain is paid for its services. Generally, merchants are responsible for paying for credit and debit card use.
Other financial transactions are expensive. Loan applications can take days to approve. You might not be able to use the bank’s services if you travel to another country.
Applications of DeFi
DeFi users typically interact with it via software called “DApps” – decentralized apps that run on Ethereum. There is no account to be opened, unlike a traditional bank.
Common Types of Defi Applications:
- Decentralized exchanges (DEXs: These online exchanges allow users to exchange currencies for other currencies. This includes U.S. Dollars for bitcoin and ether for DAI. Decentralized exchanges (DEXs) are an extremely popular type of exchange that allows users to trade cryptocurrency directly with each other without the need for intermediaries.
- Stablecoins are a cryptocurrency that is tied to an outside asset (the dollar, euro, or other currency) to stabilize their price.
- Applying for a loan: Get a loan immediately without completing paperwork. This includes extremely short-term “flash loan” loans that are not offered by traditional financial institutions.
- Lending platforms: These platforms employ smart contracts to replace banks and intermediaries that handle lending in the middle.
- Yield farming: You can put some crypto into savings accounts alternatives to banks and get better interest rates.
- Liquidity mining: provide liquidity to Decentralized exchanges to earn high-interest rates.
- Buy derivatives: Place long or short-bets against certain assets. These are the crypto equivalent of futures or stock options.
- Gambling on Event: These markets allow you to bet on future events such as soccer matches. DeFi versions can provide the same functionality, but without intermediaries.
Future of DeFi
The evolution of decentralized finance is still in its early stages. High volatility could be a result of your investment. It is not regulated for several reasons. This means that there are still infrastructural problems, hacks, and scams. However, there are also many opportunities.