What is DeFi (Decentralized Finance)?
The world of cryptocurrencies is expanding at an unabating rate. What started with a mere blockchain technology known as Bitcoin in 2008, has evolved into a whole industry of its own. Many newer cryptocurrencies make their way into the crypto-markets with each passing day, and newer blockchain technologies have emerged on to the realm of crypto scenes in order to support the acceptance and use of cryptocurrencies at a wider scale.
As the cryptocurrency space expands its horizons, the original idea of decentralization that was talked of in the Bitcoin whitepaper in 2008, keeps getting weaker. The entire ecosystem is getting bombarded with tons of new developments at such a speed that the underlying philosophies are getting increasingly plagued with sub-standard products and middle-ware. In order to make different cryptocurrencies inter-operable and to achieve some sort of synchronization between the many cryptocurrencies, solutions in form of ill-planned gateways are being implemented. This all makes the cryptocurrency space a very weakly linked infrastructure, the repercussions of which will be magnified when the use of cryptos will increase in daily applications.
On top of that, most of the trading exchanges in the cryptocurrency space are centralized. That has been the norm up till now. Imagine the irony that cryptocurrencies that talked about economic decentralization, are being traded and stored in centralized exchanges and wallets. Fortunately, this paradigm is shifting for the better as many in the crypto-universe are convinced that the era of centralized cryptocurrency exchange has to come to an end.
What is DeFi?
For the past few months, one domain that is of Decentralized Finance (DeFi) is very hot in the cryptocurrency space, and all eyes are focused towards the development of a DeFi product that can decentralize the digital economic system is its true sense. Decentralized Finance, in its simple sense, is basically the merger of traditional banking services with decentralized technologies such as cryptocurrencies and Decentralized Applications (dApps). In more technical sense, it refers to the amalgamation of all the decentralized products and services like digital assets, smart contracts, protocols, and applications.
Simple explanation of what DeFi is
This simple definition, is often unclear to a layman. This article will address this topic in more details, so that our readers can have basic understanding of what there is all with DeFi (Decentralized Finance). To absorb the details, let us put the conventional economic system in contrast. There is a central authority at the core of every economic system, such as governments and central banks. A person trust their government that they will maintain the value of their currency, their banks that they will take of our deposited money, and public companies that they will provide best return on their investments. But the phrase, that with greater trust comes greater responsibility, has always been misused. In order to remove this dependency, Bitcoin was developed in 2008.
Decentralized Finance is trying to advance the principles of self-sufficiency as it is aiming to create a financial system that is open to everyone, and does not ask its users to place trust in it. This “trustless” functionality of DeFi is its main aspect. It allows everyone to take the charge of their assets and investments, and have direct say as to what needs to be done with it. Central authorities and executive board members don’t decide for you, rather the participants of the economic network controls the dynamics of the system.
Examples of the use of DeFi
Okay, so the idea looks appealing. But what is its specific use case? Which applications will see the integration of DeFi technologies? And how can a simple user gauge the benefits it brings to the table? The simple answer to this question is that DeFi has the potential to replace every existing financial service, and that too with an add-on of decentralization. Impressive!
Lending and borrowing without a bank
In 2020 we’ve seen a big boom in DeFi coins. Most of these coins are financial platforms where you can receive interest for lending your coins. These platforms use Decentralized Finance to find lenders and borrowers and connect them to each other. This is done by a smart contract, which is mostly running on the Ethereum network.
Because of the decentralized character, you don’t have to specify your details like name, financial history or other things. Your collateral is enough to get a loan.
One of the focuses of the DeFi space these days is to build exchanges where users can buy and sell their cryptocurrencies easily, without the need of any central platform. DeFi trade exchanges will link buyers with the sellers, and the interesting part which will benefit both parties is the fact that due to the removal of the middle party, both parties will not have to pay any fees, like they did in centralized economic systems. Decentralized exchanges are called DEX for short.
DeFi is modular
DeFi is mostly build around Ethereum, which provides some amazing building technologies for decentralized applications. Blockchains are structures of blocks linked with each other. Similarly, the DeFi space takes a modular approach. Every new product or service can be thought of as a separate module, and by combining them, you can make interesting financial tools and services. The details of how the whole DeFI ecosystem works will sound very complicated to a common person. All is necessary is to take note of the fact that the system makes use of smart contracts to power the whole network.
Advantages of DeFi
DeFi has been the talk of town for the amazing advantages it can add to the current economic system. More decentralization will mean a user will enjoy greater autonomy. The accessibility of funds and trade ability between users will not be dependent on any third party. Above of all, decentralized economic facilities will bring a greater amount of transparency as compared to centralized authorities.
- Everything is online and digital
- Everyone is accepted
- Open-source code
Disadvantages of DeFi
While advantages of a DeFi space clearly put it in a winning situation, there are some shortcomings of the system as well. Though these disadvantages are not very severe and are applicable on individual level. For example, giving full control of an investment to the users can mean financial disaster, and is often-times, a risky idea. Moreover, as is the case with every online application, it open doors for cyber-attacks which can rob people off their rightful assets.
It is a well-established fact that cryptocurrencies and digital money is here to stay, and with them, DeFi will also continue to grow and expand. As of this moment, DeFi products and services are already worth over $500 million. Although very young, the world will see DeFi becoming a norm in the coming years.
Also read: Could DeFi crypto be a bubble?
Example DeFi coins/tokens
- Chainlink (trade)
- Aave (trade)
- Maker (trade)
- Compound (trade)
- 0x (trade)
- Yearn.finance (trade)
- Ampleforth (trade)