Why is DeFi important?

DeFi takes the basic premise of Bitcoin — digital money — and expands on it, creating an entire digital alternative to Wall Street, but without all the associated costs (think office towers, trading floors, banker salaries). This has the potential to create more open, free, and fair financial markets that are accessible to anyone with an internet connection. DeFi is short for “decentralized finance,” an umbrella term for Ethereum and blockchain applications geared toward disrupting financial intermediaries.

Smart contracts at the core, dozens of DeFi applications are operating on Ethereum, some of which are explored below. Ethereum 2.0, a coming upgrade to Ethereum’s underlying network, could give these apps a boost by chipping away at Ethereum’s scalability issues.

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The most popular types of DeFi applications include:

• Decentralized exchanges (DEXs): Online exchanges help users exchange currencies for other currencies, whether U.S. dollars for bitcoin or ether for DAI. DEXs are a hot type of exchange, which connects users directly so they can trade cryptocurrencies with one another without trusting an intermediary with their money.
• Stablecoins: A cryptocurrency that's tied to an asset outside of cryptocurrency (the dollar or euro, for example) to stabilize the price.
• Lending platforms: These platforms use smart contracts to replace intermediaries such as banks that manage lending in the middle.
• "Wrapped" bitcoins (WBTC): A way of sending bitcoin to the Ethereum network so the bitcoin can be used directly in Ethereum's DeFi system. WBTCs allow users to earn interest on the bitcoin they lend out via the decentralized lending platforms described above.
• Prediction markets: Markets for betting on the outcome of future events, such as elections. The goal of DeFi versions of prediction markets is to offer the same functionality but without intermediaries.
• Yield farming: For knowledgeable traders who are willing to take on risk, there's yield farming, where users scan through various DeFi tokens in search of opportunities for larger returns.
• Liquidity mining: When DeFi applications entice users to their platform by giving them free tokens. This has been the buzziest form of yield farming yet.
• Composability: DeFi apps are open source, meaning the code behind them is public for anyone to view. As such, these apps can be used to "compose" new apps with the code as building blocks.
• Money legos: Putting the concept "composability" another way, DeFi apps are like Legos, the toy blocks children click together to construct buildings, vehicles and so on. DeFi apps can be similarly snapped together like "money legos" to build new financial products.

History of Defi

Decentralized exchanges (abbreviated DEXs) as alternative payment ecosystems with new protocols for financial transactions emerged within the framework of decentralized finance,[5] which is part of blockchain technology and FinTech.[6] Unlike centralized cryptocurrency exchanges (CEXs), such as Coinbase, Huobi or Binance, which use order books to match buyers and sellers on the open market and keep crypto assets in an exchange-based wallet, DEXs are non-custodial and leverage the functionality of self-executing smart contracts for peer-to-peer trading, while users retain control of their private keys and funds.[7]

Most recently, DEX aggregators have begun to play a more distinctive part in the DEX segment. DEX aggregators form user-centric hubs that compose to several applications and protocols, also providing tools to compare and rate services, which allow users to perform otherwise complex tasks by connecting to several protocols simultaneously.[8] CEXs, DEXs and DEX aggregators are all built on the multi-layered DeFi architecture or components, where each layer serves a well-defined purpose.[5] (See Figure: Multi-layered Architecture of the DeFi Stack). While they share common components of the first four layers, such as Settlement layer, Asset layer, Protocol layer and Application layer, DEX aggregators have an additional component or Aggregator layer, which allows them to connect and interact with other DEXs via smart contracts.[9][10] The Ethereum blockchain popularised smart contracts, which are the basis of DeFi, in 2017. Other blockchains have since implemented smart contracts.

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HOW IS DEFI DIFFERENT FROM BITCOIN?

While Bitcoin is a decentralized digital currency that operates on its own blockchain and is used mostly as a store of value, DeFi is a concept that describes financial services that are built on public blockchains, such as Bitcoin and Ethereum, that for example, enable users to earn interest or borrow against their cryptocurrency holdings. DeFi is comprised of a variety of applications around financial services such as trading, borrowing, lending and derivatives.

HOW DOES DEFI WORK?

DeFi uses cryptocurrencies and smart contracts to provide financial services to eliminate the need for intermediaries such as guarantors. Such services include lending (where users can lend out their cryptocurrency and earn interest in minutes rather than once a month), receiving a loan instantly, making peer-to-peer trades without a broker, saving cryptocurrency and earning a better interest rate than from a bank, and buying derivatives such as stock options and futures contracts.

To facilitate peer-to-peer business transactions, users utilize dApps, most of which can be found on the Ethereum network. Among the more widely used DeFi services and dApps are coins (Ether, Polkadot, Solana), stablecoins (whose value is pegged to a currency such as the US Dollar), tokens, digital wallets (Coinbase, MetaMask), DeFi mining (a.k.a. liquidity mining), yield farming, staking, trading, and borrowing, lending, and saving using smart contracts.

DeFi is open source, meaning that protocols and apps are theoretically open for users to inspect and to innovate upon. As a result, users can mix and match protocols to unlock unique combinations of opportunities by developing their own dApps.

DeFi vs traditional finance

One of the best ways to see the potential of DeFi is to understand the problems that exist today.

• Some people aren't granted access to set up a bank account or use financial services.
• Lack of access to financial services can prevent people from being employable.
• Financial services can block you from getting paid.
• A hidden charge of financial services is your personal data.
• Governments and centralized institutions can close down markets at will.
• Trading hours often limited to business hours of specific time zone.
• Money transfers can take days due to internal human processes.
• There's a premium to financial services because intermediary institutions need their cut.

What can you do with DeFi?

There's a decentralized alternative to most financial services. But Ethereum also creates opportunities for creating financial products that are completely new. This is an ever-growing list.

Send money around the globe

Stream money around the globe

Access stable currencies

Borrow funds with collateral

Borrow without collateral

Start crypto savings

Trade tokens

Grow your portfolio

Fund your ideas

Buy insurance

Manage your portfolio

Financial system based primarily on Ethereum

• Decentralized finance or DeFi is a financial system that reimagines financial transactions by removing intermediaries and is based on blockchain technology, typically Ethereum.
• Various financial transactions are possible with DeFi's 'smart contracts' that execute financial transactions under certain conditions.
• There are many different decentralized applications, or dApps, and uses within DeFi that open accessibility but come with risk.

How DeFi works

DeFi, previously referred to as "open finance," takes out the middleman in financial transactions. So instead of having your bank or credit card issuer be the intermediary between you and a merchant when you make a purchase, you use the digital currency and have ownership of it to use directly. DeFi is primarily based on Ethereum, the top cryptocurrency next to Bitcoin.

Here are the main tenets of DeFi:

• There are no intermediaries, so no banks or institutions overseeing your money
• There's a level of transparency, as the code is available for anyone's review
• There are open networks that transcend geographic borders
• There are many applications for users, primarily based on Ethereum

Though DeFi is usually a main player in the cryptocurrency conversation, it goes beyond creating an alternative digital currency or value. DeFi works to replace the role of traditional financial systems through its smart contracts.

Why is DeFi important?

A societal transition away from traditional finance toward DeFi would constitute a fundamental shift in the ways we interact with forms of currency.

There are often dozens of third parties involved in your finances. We store fiat currency with financial institutions. We go through traditional banks and exchanges to digitally transfer fiat currency to friends and family. These processes can be time consuming, and potentially expensive to utilize as they often involve transaction fees.

DeFi doesn’t have the vulnerabilities or inconveniences we tend to assume are necessary.

How does DeFi differ from traditional finance?

Traditional finance is highly regulated, and there’s often a frequent amount of fees. While we obviously have a greater familiarity with traditional finance, DeFi offers:

• Much higher levels of autonomy with transactions; no permissions are needed to conduct transactions and deals can be structured without waiting periods
• Better transparency into transactions and fees
• Greater trust in the technology itself as opposed to intermediaries like banking institutions

However, these perks don’t come without potential risk. DeFi is still new territory, and it’s also less private since transactions are visible on the public decentralized blockchain.

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