What is DeFi?
Decentralized finance (commonly referred to as DeFi) is a blockchain-based form of finance that does not rely on central financial intermediaries such as brokerages, exchanges, or banks to offer traditional financial instruments, and instead utilizes smart contracts on blockchains, the most common being Ethereum. DeFi products give users exposure to global markets, alternatives to local currency, and options to avoid traditional banking. With tens of billions of dollars worth of crypto already moving through DeFi applications, DeFi grows every day and is becoming a disruptive force in international finance.
How could DeFi apply to your portfolio?
DeFi is a catch-all for various blockchain-based financial applications whose ultimate goal is to disrupt existing financial intermediaries. Fundamentally, DeFi is an open and global financial system built for the internet age. DeFi’s chief innovation is the use of blockchain technology, which underpins digital currencies like Bitcoin, to expand from simple value transfer to more complex financial applications.
DeFi products and services are available to anyone with an internet connection and access to the Ethereum platform. They allow anyone to access self-sovereign, censorship-resistant financial services. Unlike legacy digital payment methods, such as PayPal, DeFi solutions leverage blockchain to cut out middlemen from transactions. Instead of payments moving through the ledgers of private financial institutions, transactions as diverse as loans, insurance, crowdfunding, derivatives, betting and more can now move seamlessly between payee and payor with complete visibility and without the involvement of third parties.
In DeFi, smart contracts—which can hold funds and can send or refund them—replace financial institutions within these transactions. Smart contracts are unalterable once live and will always run as programmed. This allows DeFi solutions to speed up transactions, avoiding bottlenecks caused by the centralized systems of transaction guarantors. It also avoids the risk of human error by eliminating the need for human involvement and approvals, instead automatically executing deals within the smart contracts via code that anyone can inspect and scrutinize.
Uses of DeFi
As a decentralized alternative to financial services with smart contracts at their core, DeFi has a variety of applications that mirror existing financial mechanisms as well as truly novel concepts like yield farming, liquidity mining, or flash loans made without collateral or requirements to provide any personal information.
Here are some of the most popular types of DeFi applications:
- Decentralized exchanges (DEXs): Online exchanges help users exchange one currency for another, such as bitcoin for ether, or even for fiat currencies like US dollars. DEXs connect users directly so they can trade cryptocurrencies with one another without trusting an intermediary with their money.
- Lending platforms: Connects borrowers to lenders of cryptocurrencies. Users make money from interest for lending out their money. Most DeFi lending is collateral-based, often in the form of ether, the Ethereum-based cryptocurrency. And because it’s collateral-based, users aren’t required to provide their identity or reveal a credit score to take out a loan.
- Stablecoins: Provides a form of cryptocurrency pegged to the value of fiat currencies, like the euro or the US dollar. The goal of stablecoins is to insulate cryptocurrency holdings from some of the volatility that cryptocurrencies can experience and stabilize their value for coin owners over time.
- “Wrapped” bitcoins (WBTC): Provides a means of sending bitcoin to the Ethereum network for use in Ethereum’s DeFi system. Users can earn interest on the bitcoin they lend out as WBTC via decentralized exchanges (DEXs).
Advantages of DeFi
Blockchain-based DeFi financial services offer particular advantages over traditional legacy financial service institutions. The primary benefits of DeFi include the following:
- Permissionless access: Only an internet connection is required to access these services
- Censorship resistant: There is no central party involved in transactions that can reverse transactions or turn off the service
- Trustless: Users don’t have to trust a central party to ensure the validity of transactions
- Transparent: Public blockchains like Ethereum are entirely transparent and auditable
- Programmable: Developers can create and intertwine financial services at a very low cost
- Efficiency: Open financial services are powered by code, not humans, and avoid middlemen
With over 200 projects on the Ethereum network and over $60 Billion in locked-in value, including automated credit platforms, foreign exchange systems, derivative contracts, and artwork trading, DeFi stands poised to re-engineer the financial ecosystem.
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