DeFi Explained

DeFi, standing for Decentralized Finance, is a brand new way to conduct banking that cuts out the middleman – old-fashioned centralized banking institutions. It implies the employment of technology, infrastructure, and practices to automate and hence redefine people’s everyday financial routine like transactions, making it more democratic, accessible, and transparent. DeFi services are powered by […]

Date published:

14 September 2022

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Date modified:

14 September 2022

DeFi, standing for Decentralized Finance, is a brand new way to conduct banking that cuts out the middleman – old-fashioned centralized banking institutions. It implies the employment of technology, infrastructure, and practices to automate and hence redefine people’s everyday financial routine like transactions, making it more democratic, accessible, and transparent.

DeFi services are powered by self-invoking smart contracts promoting direct P2P crypto coin asset interaction. In this they dramatically differ from banks that not only round up all their customer’s funds in one place, retaining superior authority over the money, but also require much more manual intervention. Speed, security, and trust in such a setup leave much to be desired.

What is DeFi (Decentralized Finance)?

DeFi is a highly inclusive worldwide open-source ecosystem of financial services extending across borders. It runs parallel to CeFi – traditional banking systems considered as a whole – and offers the complete set that the latter features well as brand-new ways to put liquid assets to work. People can lend and borrow, earn interest, trade assets and derivatives, shop for insurance, and do other fascinating things using their cryptos. Only now it’s swift, traceable, and entails no go-betweens and stationery.

Decentralized Finance shot up in popularity in the years leading up to 2022 to appeal to vast swaths of people from varying walks of life all around the world. Today, the entire infrastructure is already worth over $20B according to its combined TVL (total value locked – the value of crypto assets put into DeFi contracts). It’s still slim compared to Centralized Finance, yet taking into account that the whole industry is just several years old, DeFi is a major development on our way to democratizing and optimizing banking and investment tools.

What is the Difference Between DeFi and CeFi (Centralized Finance)?

For us to provide you with a better understanding of how DeFi and CeFi are different, let’s juxtapose the two to conclusively demonstrate the former’s benefits:

  • In CeFi, you have to voluntarily entrust a separate organization with keeping funds on your behalf, while in DeFi you are your purse. Just imagine having your billfold digitalized and safely encrypted.
  • To start enjoying CeFi opportunities, you have no choice but to go through a selection process where you can be denied service, whereas in DeFi you can join with a couple of taps from anywhere.
  • In CeFi, moving means to another country or state takes ages (several days to be more precise). In DeFi, it’s a matter of minutes.
  • In CeFi, money flows are often kept away from the public eye for various reasons and can only be traced with the help of law enforcement sometimes, but DeFi entitles everybody to track down any financial move and view complete transaction history anytime.
  • In CeFi, you can only make trades when markets are open, which is people’s normal working hours that may differ drastically from your time zone. In DeFi, on the other hand, all the systems are operational around the clock.

How Does DeFi Work?

Decentralized Finance was made possible by deploying smart contracts – the programs that self-enforce once the conditions coded into them are met – on blockchains – global cryptographically reinforced computer networks that store and maintain databases facsimiles of which are distributed throughout numerous participating notes validating transactions.

Such a thoroughly streamlined approach yields substantial benefits: with no intermediaries, there’s no one to interfere with, withhold, or outright block any of your payments or other transfers. All you need is a device connected to the internet and a couple of minutes of free time to download a DeFi-compatible wallet, preferably the one with a web3 browser built in (the browser developed to facilitate interaction with decentralized platforms).

DeFi Protocols Explained

DeFi protocols are one of the most vital components of the DeFi network – they constitute the backbone of dApps (decentralized apps – apps taking advantage and running on top of blockchains).

First things first, you shouldn’t be afraid of the term, as it had been used in the realm of computer science well before Decentralized Finance emerged and simply means an agreed list of rules in conformity with which any subsequent code should be developed to execute smoothly and achieve the end goal.

Speaking of DeFi protocols, they are not merely instructions but pieces of code themselves and are used to build dApps. Protocols are huge time-savers when it comes to writing new features. For instance, faced with the need to enable a conditional token transfer from A to B, the developer can go ahead and integrate code that’s already been assembled, deployed, and served well for some time. They would alter the necessary parts for the whole thing to fit the purpose, add what’s missing – and the desired functionality is good to go. This helps promote efficiency and dependability in the realm of DeFi solutions.

The most popular DeFi protocols by far are decentralized lending & borrowing platforms, DEXs (decentralized exchanges) – crypto asset trading platforms, crypto asset management tools (DeFi wallets being a great example), DPMs (decentralized prediction markets) – exchange-traded markets for real-world event outcome speculating, DIPs (decentralized insurance platforms), and various cross-chain (blockchain-to-blockchain) and multichain (products supporting multiple blockchains) solutions, among others.

Meaning of Crypto in DeFi

DeFi is built around and for crypto assets – fungible coins and tokens, and NFTs. It uses blockchain technology coupled with cryptocurrencies to fuel financial dealings.

Many enthusiasts exploring truly countless opportunities inside Decentralized Finance often use the terms tokens and coins as if they were interchangeable. But this is not the case, despite their being very alike superficially.

It all starts with coins, and DeFi ones largely emulate fiat currencies circulating in the world of ordinary finance. They are also called, don’t be confused, blockchains’ native tokens. The most popular examples would be BTC, ETH, BNB, NEAR, and others. Those are blockchain networks’ fundamental currencies – their coins that are involved in processing transactions and levying gas (=transaction) fees.

DeFi tokens, on the other hand, are issued atop blockchains powered by one specific coin and are not used to pay for transactions. They always conform to their blockchain’s governing standard (like ERC20). One blockchain can host myriads of such tokens. DApps usually employ tokens as internal currencies, while protocols can enable financial opportunities for them. It all depends on the utility the developer (and/or community) devise for their particular one. Tokens. There are governance and asset tokens (representing the ownership of physical world property) to name a few that may not have any market value. And surely we shouldn’t forget about NFTs – unique ones that can cost hundreds of bucks.

When it comes to crypto coins and tokens it’s crucial to dig into their technology and utility before investing

There are also cryptocurrencies called stablecoins. The concept of these is the easiest to grasp for most beginners and they are the handiest to manage too for that matter. Stablecoins, as the name implies, are as of now less volatile. That’s because stables are pegged to fiats, so 1 USDT, for example, is always roughly $1. Companies utilize different collateralization mechanisms to accomplish this, and it’s always advisable to do your own research before picking a stablecoin to hold your possessions in.

DeFi – the Future of Finance?

Peeping into the future, it’s fair to speculate that DeFi use cases are bound to multiply, with new speedy, highly efficient, trusted, and sometimes unprecedented financial and investment tools on their way to hit the stage short term. Imagine high-yield crypto savings accounts available in several taps.

Long term, DeFi has real potential to supersede Centralized Finance and contribute to the complete tokenization and decentralization of the world economy if not stunted by precipitous legislation.

The realization of how much has already been achieved in the CeFi domain is spurring banking entrepreneurs to reproduce and optimize that on blockchains in an exceptionally distributed and democratized fashion.

Final Words

DeFi is one of the most conspicuous and momentous phenomena enabled by blockchain technology. Originally made possible by Ethereum – the first-ever programmable blockchain – DeFi is now spreading across multiple different Layer 1 (such as Ethereum or BNB Chain) and Layer 2 blockchains (networks built around Layer 1 ones to improve their infrastructure in some way such as scalability, e.g. Polygon) that studied ETH’s groundwork to offer even more affordable transfers. Numerous DeFi projects – banking and trading platforms, wallets, coins, tokens, and interoperability solutions – are launching daily from around the globe with no regard for borders, as those are nonexistent in the world of Decentralized Finance.

DeFi is a very promising and automated financial ecosystem giving our normal banks a run for their money. And considering the fact there are some 1.7 billion unbanked majors still out there, its extensive connectivity power may bring an astonishing amount of new people into finance for it to thrive at a scale never before heard or seen.

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