ALL YOU NEED TO KNOW ABOUT DEFI
What is DeFi (decentralized finance)?
After Bitcoin’s launch in 2009, a robust industry blossomed, stemming from the asset, its concept and its underlying technology. The crypto and blockchain space boasts different niches in which projects and companies develop solutions for various use cases.
One such niche is the decentralized finance (DeFi) sector, which was created as an alternative to traditional financial services. More specifically, DeFi consists of smart contracts, which, in turn, power decentralized applications (DApps) and protocols. Many of the initial DeFi applications were built on Ethereum, and the majority of the ecosystem’s total value locked (TVL) remains concentrated there.
At its core, Bitcoin
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carries qualities touted as pillars of decentralization. DeFi, however, expands on those qualities, adding additional capabilities.
A subcategory within the broader crypto space, DeFi offers many of the services of the mainstream financial world in a fashion controlled by the masses instead of a central entity or entities.
Lending may have started it all, but DeFi applications now have many use cases, giving participants access to saving, investing, trading, market-making and more. Decentralized finance’s ultimate goal is to challenge and eventually replace traditional financial services providers. DeFi often harnesses open-source code, allowing anyone the opportunity to build on pre-existing applications in a permissionless, composable manner.
“Finance” is easy to understand, but what is “decentralization?” In short, decentralization means that no chief body controls something. To an extent, banks and other financial institutions have power over your funds. These entities can freeze your assets, and you are at the mercy of their hours of operation and cash reserves.
The decentralization aspect of DeFi is not only a dispersal of power but also a dispersal of risk. For example, if a company holds all of its customer data in one spot, a hacker needs only to access that particular site for a vast amount of data. In contrast, storing that data across several locations or removing that single point of failure could improve security.
This article will explain what DeFi means, how DeFi works and throw some light on DeFi trading and decentralized banking.
DeFi vs. CeFi (Centralized Finance)
For this comparison, commercial banks will be used as an example. In the traditional world, you may use financial institutions to store your money, borrow capital, earn interest, send transactions, etc. Commercial banks carry a lengthy, proven history of performance. Commercial banks can provide insurance and have security measures in place to ward off and protect against theft.
On the other hand, such establishments hold and control your assets to a degree. You are limited by banking hours for particular actions, and transactions can be cumbersome, requiring settlement times on the back end. Additionally, commercial banks require specific customer details and identifying documents for participation.
DeFi is a segment that comprises financial products and services that are accessible to anyone with an internet connection and operates without the involvement of banks or any other third-party firms. The decentralized financial market doesn’t sleep and therefore, transactions take place 24/7 in near real-time, while no intermediary has the power to stop them. You can store your crypto on computers, in hardware wallets and elsewhere, and gain access at any time.
Bitcoin and most other cryptocurrencies hold these characteristics due to the underlying technology that backs these assets. Thanks to DeFi’s dependence on blockchain technology, transactions are completed faster, cheaper and — in some cases — more securely than they would with human intervention. Decentralized finance seeks to use crypto technologies to solve a plethora of issues that exist in the traditional financial markets:
People or companies in centralized finance handle the asset class and processes. However, assets are handled by a collection of smart protocols in decentralized finance. It all boils down to having faith in the people or organization behind the platform. CeFi platforms, like Coinbase.com, are custodial, which means it stores crypto for you. You can, however, utilize a Coinbase wallet in the same way you would a regular cash wallet, giving you complete control over your crypto assets.
Overall, DeFi allows participants the opportunity to access borrowing and lending markets, take long and short positions on cryptocurrencies, earn returns through yield farming, and more. Decentralized finance has the potential to be a game-changer for the 2 billion unbanked people in the world, in particular, who don’t have access to traditional financial services for one reason or another.
DeFi solutions are built on various blockchains, with the ecosystems composed of participants interacting in a peer-to-peer (P2P) fashion, facilitated via distributed ledger technology and smart contracts, which keep the systems in check. Such results are not bound by geographic borders and do not require identifying documentation for participation.
The framework for this financial system functions according to programmed rules. Instead of using an intermediary such as a bank to borrow capital, you would send amounts of a specific cryptocurrency to a secure digital location — a smart contract — as collateral for your loan, receiving a different asset in return. Your collateral assets would then sit locked up until you send back the loan amount.
Though you may or may not interact in a straightforward P2P manner when using DeFi solutions, the spirit of the process is P2P, in that third parties are replaced with technology that is not ruled by a central authority.
