What Is DeFi (Decentralized Finance)?

Decentralized Finance (DeFi) 101

1. What is DeFi?

DeFi, short for Decentralized Finance, refers to a set of financial services and applications built on blockchain technology. It aims to recreate using decentralized networks, enabling access to financial services without relying on traditional intermediaries like banks.

2. What are some common DeFi applications?

Common DeFi applications include decentralized exchanges (DEXs), lending and borrowing platforms, yield farming, stablecoins, prediction markets, and decentralized insurance. Examples include , , , , and .

3. What are Decentralized Exchanges (DEXs)?

DEXs are platforms that enable users to trade directly from their wallets without an intermediary. They use smart contracts to facilitate peer-to-peer trading, offering increased privacy and control over assets.

4. How do I get started with DeFi?

To get started with DeFi, you'll need a , some cryptocurrency, and an understanding of DeFi platforms. You can then choose a DeFi application, provide liquidity, trade, or participate in other DeFi activities.

5. Is DeFi only for experienced users?

DeFi can be used by both beginners and experienced users. You can start with small amounts and learn more about the specific DeFi platform you're using.

What Is DeFi’s Role in a Changing Financial World?

The finance industry is undergoing a period of foundational change, much of which has been brought about by new types of . Perhaps one of the most groundbreaking sectors of FinTech is . Blockchain-based technologies like cryptocurrency and DeFi are facilitating entirely new financial products and services that can reduce reliance on legacy gatekeepers and traditional finance industry stakeholders. Below, we’ll outline transformative effect on finance today.

The wide-scale proliferation of DeFi technologies has given rise to a new paradigm of financial products and services that leverage blockchain and digital assets. Decentralized finance platforms are built atop blockchain protocols that operate in a fashion — with low to no reliance on centralized intermediaries such as brokerages, exchanges, or banks. DeFi protocols tend to offer a variety of such as , borrowing, lending, investing, and trading. The growth of the industry has been staggering, reaching up to $100 billion USD in value locked in DeFi projects in 2021.

How Does DeFi Work?

Over the past several years, most blockchain-specific decentralized finance projects — protocols such as , , and — have been developed exclusively on the blockchain. However, DeFi has expanded to other networks like , , , , and other networks that offer certain benefits and specialities. Regardless of the specific chain, the DeFi proposition remains the same. Let’s examine some of the strongest attributes of DeFi protocols.

Decentralized and permissionless

As noted above, one of DeFi’s main characteristics is its users’ ability to leverage various financial services in a decentralized manner, which means in a and nearly instantaneous fashion. A is a blockchain system that can be used by a network participant without obtaining permission from a centralized authority or any other entity. Permissionless blockchains are typically constructed in an open and decentralized manner employing the use of their own cryptocurrency. They operate in a manner and are generally considered open, public, borderless, neutral, censorship-resistant, transparent, and immutable.

Non-custodial

The majority of DeFi solutions operate in a manner. This means that they do not hold on to your funds in the way a bank normally does. Instead of relying on or systems, users are able to leverage any number of financial instruments (DeFi lending, DeFi borrowing, DeFi staking, and more) on their own terms, without the types of third party approval or custody that a bank requires, and can remove their funds whenever they want. This gives users a high degree of control over their DeFi investment decisions in real time, often through a mobile wallet or DeFi application on their computer or mobile device.

Immutable

Immutability is the characteristic of data becoming irreversibly codified in the shared data ledger of a blockchain network after transaction execution. DeFi technologies and blockchain systems are , irreversible, and tamper-proof through verifiable cryptography, making it practically impossible to change, reverse, or falsify records. Immutability helps allow DeFi systems to be secure, private, and transparent, which is vital to the long-term viability of the industry and safety of DeFi users.

Programmable

Through , systems allow users to carry out specific tasks in real time without an intermediary. Such tasks include executing contractual agreements and triggering on-chain mechanisms to make various financial services possible. Because of their autonomous, secure, and open nature, programmable DeFi networks typically offer low operational costs. These DeFi solutions may save time, capital, and labor when compared to the majority of database solutions.

Open and interoperable

Most public DeFi ventures operate using an open framework, meaning that they are designed to be accessible to anyone with access to the internet. Further, the full potential of DeFi crypto systems is contingent on network , which refers to the ability of various blockchain protocols to work and interact with each other and transfer value (such as digital assets) between each other through .

Decentralized Finance Trends and Solutions

Now, let’s examine some examples of the many types of financial products and services made possible through DeFi.

DeFi lending/borrowing and DeFi staking

While DeFi has many uses, perhaps the most common thus far has been protocol-specific money markets. 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. One of the leading examples of a decentralized P2P money market is Compound, which was one of the pioneering protocols to legitimize DeFi in crypto. MakerDAO is another pioneer in the decentralized lending and money market space. Moreover, current industry leaders such as , , Venus, and are examples of exchange protocols employing the use of collectivized DeFi investment pools.

Decentralized exchange platforms

A is a P2P marketplace that connects cryptocurrency buyers and sellers. In contrast to , decentralized platforms are non-custodial, meaning a user remains in control of their private keys when transacting on a DEX platform. In the absence of a central authority, DEXs employ smart contracts that self-execute under set conditions and record each transaction to the blockchain. , , , and , are examples of leading DEX protocols.

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, , and interest rates. , , , and are examples of synthetic asset blockchain platforms.

Non-fungible tokens

are immutable, verifiable cryptographic assets that can represent anything from trading cards to artwork to special access passes. Recently, NFTs have continued to expand their market share and are quickly becoming one of DeFis biggest markets. , , and are examples of blockchain platforms that make use of in-game play-to-earn systems that reward users with different types of NFTs. Leading NFT marketplaces such as have cemented themselves as the go-to platforms for the purchase and trading of .

Central bank digital currencies (CBDCs)

are cryptocurrencies minted by governments and major banks in nations throughout the world. In addition to Ethereum, numerous blockchain protocols have been designed to offer networks capable of managing the use of CBDCs including Cardano, , and . While CBDCs are generally centralized initiatives rather than DeFi projects, many experts predict that CBDCs and DeFi will increasingly dovetail as complementary parts of an emerging next-generation global financial system, with CBDCs showing strong potential to function as onramps into the DeFi ecosystem.