Beginners GuideDeFi

Decentralized Finance (Defi) Concept in the Layman’s Terms

Decentralized finance which is more commonly known as Defi is a platform built on blockchain technology. This makes it different from traditional finance applications. Blockchain technology usually relies on huge open-source networks.

In recent years, decentralized finance (Defi) has evolved as one of the most prominent technological developments. 

In this article, we will provide a complete overview of decentralized finance (Defi) and its other aspects. Let us look into this decentralized finance (Defi) review in detail now.

Background

There are about more than 1.7 billion people who do not have any access to basic financial needs. Also, there was a need to rule out the point of failure for the identical records kept around different computers. Thus Defi came into existence offering ideal solutions to overcome these problems.

Defi is a platform built on the blockchain. It includes some of the major components such as dApps, digital assets, protocols, and smart contracts, all of these built on the blockchain platform. This can be accessed and is open to everyone since it is permissionless. Decentralized finance (DeFi)  is also commonly referred to as Open Finance. 

One of the main significant benefits of DeFi is that it provides an open ecosystem for individuals who otherwise would not have access to any financial services. It offers convenient access to those users. 

What is DeFi?

DeFi typically means Decentralized Finance. It is a financial product that is based on the blockchain platform. DeFi is a system of open, permissionless, and interlocking financial products.

There are some of the traditional financial systems such as derivatives, exchange, lending, and borrowing. DeFi primarily strives to recreate these systems by automation instead of the middlemen. After the automation, the financial blocks of DeFi can be utilized to form more complex capabilities.

Traditional vs Decentralized Finance: How Different is DeFi From Other Banking Products?

Defi shows several differences between traditional banking and other financial products. The Defi operations are not taken care of by any of the institutions or middlemen. Once a smart contract is being deployed into the blockchain, the Defi applications can operate without any of the human intervention.

The Defi apps are extremely transparent. This helps in its development by any of the users present anywhere in the world. It also increases the trust factor between its users. Defi services can be accessed globally throughout the world.

The users can directly interact with the smart contracts through the crypto wallets which rules out the inclusion of any of the middlemen. There are no restrictions imposed as anyone from anywhere can create and access the decentralized finance applications.

How can Decentralized Finance be Applied to the Real World?

Defi brings in the potential to change the lives of individuals who are unranked in the world. There are usually daunting fees paid by individuals to send money across different borders. Defi intends to cut down these costs by about more than 50%.

The open finance platforms have shown extensive growth and their adoption has to lead to a transformation in people’s lives. Defi helps in the expansion of the economies and the productivity of the employees.

Defi also helps in granting loans to the unbanked. Due to the credit score and the other related things it becomes nearly impossible for the common people to access the loans. Defi helps in ruling out this possibility of such problems as they connect the lenders with the borrowers.

How Does DeFi work?

DeFi operations are not taken into account by any organization or its employees. Instead, the set of rules is mentioned in the smart contract or the code. Once the smart contract is assigned to the blockchain, the DeFi apps can run independently without any human need.

It offers the transparent code on the blockchain so that any user from anywhere can audit it. This forms an additional trust in its users as anyone can access the platform. However, similar to any computer code, smart contracts can be vulnerable to both unintended programming mistakes and malicious hacks.

Key Components of DeFi

DeFi offers some of the major key components which can be listed as below:

1) Transparency: DeFi provides excellent transparency to its users. All the transactions are being publicly available. It differs from the traditional banking system as it is not linked to anyone in specific

2) Open Source: DeFi offers an open-source coding platform. It refers to the fact that coding is made public. Further, it also ensures more trust in the users as there is no hidden coding running in the background.

3) Global Audience: DeFi offers its platform to the global audience, meaning anyone from around the world can take part in the DeFi platforms. With the help of a Smartphone and with internet access you can enter the DeFi community in minutes.

4) Permissionless: This refers to the fact that anyone can participate in DeFi Dapps without any concern for approval.

5) Flexibility: The users can exercise more flexibility in their platforms as a result of the open nature of the DeFi platform. In fact, users can even choose to build their own interfaces if they find the current options insufficient.

DeFi Ecosystem and its products 

The different products included in DeFi are generally known as Open finance. It forms an ecosystem where different open protocols, digital assets, and the blockchains get merged with traditional  financial structures

Any single points of failure are eliminated as these new financial services are deployed on top of blockchains. The data is completely monitored safely on the blockchain and also distributed across the platform eventually ruling out the possibility of censorship and related issues.

How are DeFi applications produced?

The DeFi applications can be created by anyone if you are capable of writing smart contracts. Currently, 193 projects out of the 205 listed DeFi projects are being built on the Ethereum platform. Most of them include lending dApps.

The lenders and borrowers can interact directly, through smart contracts. This brings issues within the traditional global banking systems and offers an alternative, decentralized solution. The ecosystem gets more diverse as more of the funds get aggregated into the DeFi Sector.

DeFi Stablecoins

It is most desired to use crypto assets with lower volatility. At the same time, they need to possess all the required advantages of blockchain technology. One of the specific category of cryptocurrencies which show low volatility is the decentralized stable coin.

These stablecoins achieve their low volatility by pegging their value to a national currency such as the US Dollar. Some of them are even pegged to a collection of different currencies. It also has to be noted that there is no central authority that issues these decentralized stablecoins.

Here are some of the types of stablecoins which can be listed below: 

1) Fiat-collateralized: It is backed by an individual currency or basket of currencies

2) Crypto-collateralized : They are backed by the crypto assets, most commonly ether

3) Resource backed: It is a stable coin that is backed by another asset, such as gold

4) Hybrid models : These are the models that combine any of them or add other attributes in order to maintain stability

DeFi Money Market

The decentralized money markets mainly focus on allowing its users in borrowing or lending various crypto assets. They can be considered as an alternative to the traditional banking system that lends or borrows through the money platform.

One of the major differences between the traditional banking system and the decentralized money markets is that the decentralized money markets are open to all of its users and get access to the financial infrastructure that cannot access it.

There is a wide range of DeFi platforms that provide borrowing and lending of Ethereum tokens namely, Compound, Maker DAO, Kyber, and more. These make use of the concept of smart contracts. The smart contract helps in replacing the middleman. Also, the interest rates are done accordingly to supply and demand.

DeFi – Decentralized Exchange

DeFi also offers a source for the decentralized exchange (DEX). Here the transactions are directly carried out on the blockchain. This is beneficial when compared to the traditional exchanges wherein it is being stored in the centralized servers.

The decentralized exchanges strive to carry out the trades of different cryptocurrencies between the two users. There are a wide number of decentralized exchanges that have evolved recently and are under operation.

Importance of DeFi

Over the years, In order to manage our money and the investments, we are involved with the centralized platforms. They are notably the governments, financial advisors, and the banks which we entrust upon them. There is a lack of transparency in its operation.

Thus DeFi is a financial platform that strives to provide complete transparency to all of its users. One of the main advantages of the blockchain is that all of the users get to know all processes and events which are happening on the network. The DeFi platform makes use of the cryptocurrencies as their prominent banking feature.

Challenges Associated with DeFi

There are some challenges associated with Defi similar to the other financial products. The users have to take care of their holdings and also have to take into account the deal of multi-factor authentication with privacy.

There have been additions of high-security measures and privacy algorithms in the interface. This was in reply to the many privacy-related incidents that occurred in the past. One must also keep updated with the changes taking place in the different crypto projects and exchanges.

Another important challenge ahead of Defi is the fact of the historical data. When compared to the traditional currencies they have the proper historical data and other resources for the investors. Whereas Defi lacks such resources and benchmarks which can be challenging. 

Future of DeFi

As we have seen services like derivatives, borrowing, lending, custody, and exchange built for the crypto. In the upcoming years, we could possibly see every financial service used today being rebuilt for the crypto ecosystem.

Another thing which can be seen is a better user experience. The first generation of dapps was built by blockchain enthusiasts for blockchain enthusiasts. The latest possibilities of DeFi apps are prioritizing design and ease of use in order to take open finance to a wider audience.

Conclusion

DeFi systems make use of the codes and the protocols for the process automation which distinguishes itself from the traditional financial products. It also helps in eliminating the human error which can take place.

Decentralized finance offers some of the very unique features and hence has become an integral part of the crypto economy. Thus decentralized finance could very well be the next emerging thing in the blockchain platform. 

FAQ’S

  1. What is DeFi?

    DeFi is short for Decentralized Finance. Decentralized Finance includes digital assets, protocols,  smart contracts, and dApps built on a blockchain.

  2. What is a DeFi token?

    DeFi has created a suite of highly demanded tokens within the larger cryptocurrency ecosystem. With DeFi tokens outperforming BTC in 2020, the ecosystem is quickly turning towards popular protocol tokens as a means of value capture for DeFi's growth.

  3. Are their risks for Defi?

    Securely handling cryptocurrencies and finance tools require specialized knowledge, Hence there is a risk factor involved. It is the user’s responsibility to keep their key and holdings secret, use a hardware wallet and multi-factor authentication.

  4. Why do we need DeFi?

    Crypto is just one of the components that enable Defi to provide transparent and more profitable financial products. On its own, cryptocurrency provides a medium for facilitating transactions without the hassles prevalent with traditional fiat currencies.

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Decentralized Finance (Defi) Concept in the Layman’s Terms
Article Name
Decentralized Finance (Defi) Concept in the Layman’s Terms
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Decentralized finance which is more commonly known as Defi is a platform built on blockchain technology. In recent years, it has evolved...
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Elena
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Coinpedia
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Elena R

Elena is an expert in technical analysis and risk management in cryptocurrency market. She has 10+year experience in writing - accordingly she is avid journalists with a passion towards researching new insights coming into crypto erena.

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