What Is the Difference Between DeFi and Web3?

 The Beginning of DeFi and Web3 

The internet has been such an integral part of human life for long enough now that its development can be broken down into a number of distinct phases. These phases characterize technological advancement, the way we interact with digital technology, and the effect that relationship has on society and the economy. Beginning in the mid-1990s, the first consumer-ready version of the internet became available. This phase is referred to as Web1. Web1 allowed for the creation of basic websites and internet applications that changed both society and financial systems. This era was embodied by the dot-com boom and its generation of development and growth.

Next came Web2, which introduced a more user-focused, interactive internet that allowed for the sharing of data in a more efficient and equitable manner than was previously possible. This era of the internet covers everything from Myspace to Facebook to online banking and mobile apps, and still drives much of today’s internet experience. That said, many believe the Web2 internet is flawed due to its heavy reliance on centralized architecture and rent-seeking economic models. Web3 — which relies largely on blockchain — has gained traction in recent years with promises of decentralization, more equitable access, and more democratized economic models.

While the launch of Bitcoin in 2009 was the inception point for both blockchain and crypto, it was the launch of Ethereum in 2015 that introduced a new framework allowing for the expansion of blockchain tech into anything resembling Web3. Ethereum smart contracts allow decentralized networks to fulfill a wide range of innovative uses related to fundraising, decentralized finance (DeFi), non-fungible tokens (NFTs), decentralized autonomous organizations (DAOs), stablecoins, the metaverse, and blockchain gaming.

A key sector in the growth of the Ethereum blockchain and Web3 has been DeFi. DeFi refers to a dynamic ecosystem of open platforms, financial products, and financial instruments that represent an innovative financial system that operates in a more open, permissionless, and equitable manner. While Web3 refers to a larger technological and social phenomenon, DeFi can be thought of as a particular sector in the wider Web3 crypto trend.

Decentralized Finance: A Subsector of Web3

While Web3 is predicated on using blockchain technology to create a more equitable internet, decentralized finance is Web3’s version of a more transparent financial system. To this end, DeFi is quickly becoming a new paradigm that allows new forms of value and utility not seen within the traditional financial system.

Initially through Ethereum, and now increasingly via other Layer-1 blockchains, DeFi solutions are fueling financial utility in a vast number of ways through smart contract technology. The majority of these solutions allow users to manage their funds in a non-custodial manner through a DeFi crypto wallet. Let’s explore some of them in more detail:

Decentralized exchanges: A decentralized exchange (DEX) is a peer-to-peer (P2P) marketplace that allows cryptocurrency buyers and sellers to interact. In contrast to centralized exchanges (CEXs), DeFi platforms are non-custodial, meaning a user remains in control of their private keys when transacting. In the absence of a central authority, DEXs employ smart contracts that self-execute under set conditions and record each transaction to the blockchain.

Lending, borrowing, and staking: Multi-purpose peer-to-peer money markets that host a variety of products and services are perhaps the most common use for DeFi platforms. Decentralized money markets allow users to borrow, lend, and stake crypto assets by providing liquidity to the protocol through different types of collectivized liquidity pools (LPs). DeFi lending markets continue to evolve as more approaches for capital deployment and investment are realized regularly.

Synthetic assets: Synthetic assets allow for the creation of blockchain-based tokenized assets that mimic real-world assets such as stocks (equities), bonds, commodities (i.e., gold and silver), indexes, fiat currencies, and interest rates.

Non-fungible tokens (NFTs): NFTs are immutable, verifiable cryptographic assets that can represent anything from trading cards to artwork to special access passes. NFTs have continued to expand their market share and are becoming one of DeFi’s biggest markets. These assets are regularly employed within blockchain platforms that make use of play-to-earn (P2E) systems that reward users for their in-game efforts. Furthermore, it has become commonplace for NFTs to be traded and exchanged on NFT marketplaces for the purchase and trading of NFT cryptoart, digital art, music, and other mediums.

In addition, DeFi crypto options are increasingly being deployed for the transfer, use, storage, and trading of numerous types of crypto assets such as stablecoins, governance and utility tokens, and liquidity provider tokens, among others. DeFi, through numerous Layer-1 blockchains, is also being utilized as an interoperable framework for the management, transfer, and use of central bank currencies (CBDCs) between legacy financial infrastructure.

Characteristics Shared by DeFi and Web3 Explained

While blockchain and Web3 are separate from decentralized finance, they share many similar characteristics. Most notably, they employ decentralized systems that are:

Permissionless and open: DeFi and Web3 crypto projects alike are designed to be permissionless, open, and equitable. Permissionless means that users don’t need permission from a centralized entity to make use of the network. Open, public blockchain systems (which the Web3 term is meant to represent) operate in a way that allows anyone to participate. This functionality allows users to access their crypto wallet and additional network-specific infrastructure from their laptop or smartphone with a few clicks.

Decentralized: In a blockchain context, decentralization means that the network operates independently from the control of a centralized intermediary, usually evidenced by a widely distributed global network of nodes that furnish the network’s operation.

Interoperable: Interoperability is the capability of different blockchain networks and DeFi platforms to share data, technology, and tokenized assets with one another in a seamless manner.

Non-custodial: Non-custodial means that users’ funds are not held by a bank or financial service provider. Instead of relying on centralized systems, users are able to leverage numerous financial instruments (lending, borrowing, staking, and others) on their own terms. This, without the custodianship or approval of a bank, allows users to remove their funds at any time.

Programmable: Programmability is the ability for software engineers to develop network infrastructure that is able to accomplish a nearly limitless number of use-case specific iterations. This is typically realized through smart contracts, which allow users to carry out specific tasks in real time without an intermediary. These tasks include the execution of predetermined contractual agreements, the exchange of value and data, and other on-chain mechanisms.

Immutable, cryptographically verifiable: Additionally, DeFi chains and blockchain systems are immutable, tamper-proof, and irreversible, through verifiable cryptography, making it nearly impossible to change, reverse, or falsify records on-chain. Immutability helps allow DeFi crypto systems to be more secure, private, and transparent, which is vital to the long-term viability of the industry.

Token-based economic and governance systems: Both DeFi and Web3 employ economic systems and governance structures that are largely based on asset tokenization and decentralization. Many blockchain platforms and DeFi platforms are built using Proof-of-Stake (PoS) infrastructure, which allows network participants to have a say in how these systems evolve over time. The ability for users to buy, trade, and invest in digital assets that are fractionalized and fully divisible significantly lowers the barrier to entry for users when compared to traditional approaches.