DeFi stands for decentralized finance. This is a broad category of the financial infrastructure that includes lending protocols, lending platforms, and collateralized stablecoins. It’s meant to be an alternative to centralized finance, which has been the norm for hundreds of years now.
In the early days of cryptocurrency, there was no idea of DeFi because all financial activities had to happen on centralized exchanges or wallets. Satoshi Nakamoto promised to provide trustless money–meaning you didn’t have to trust third parties with your funds anymore–and blockchain technology delivered on that front by eliminating the need for banks and other intermediaries between you and your transactions. However, since then, we’ve gone back to using centralized intermediaries–crypto exchanges, custodial wallets, and other services that store private keys on behalf of their customers.
Why is decentralized finance necessary?
The most important reason is that it allows you to own your funds directly, giving you the same range of choices as you would have with traditional money. When your funds are held on a decentralized platform, there is no intermediary controlling them no matter what happens to the cryptocurrency’s price, volatility, or liquidity.
The other important reason is that decentralization enables experimentation with new types of finance. Before blockchain, no one had the power to create their own money or loan out money directly between peers because there was simply no way to do so. You needed a trusted third party like a bank or government to verify transactions and issue credit. Now that we have blockchains, there’s nothing stopping developers from creating innovative financial products like decentralized lending platforms, collateralized stablecoins, decentralized exchanges, remittance markets, derivatives markets, and much more.
DeFi gives access to financial services to anyone with an internet connection. This means that people in developing countries can now get loans, save their funds, or participate in global financial markets even if they don’t have a formal bank account or credit history. Decentralized finance will also enable entrepreneurs worldwide to achieve milestones faster than before because it gives them access to capital without having to go through the hoops of traditional finance, which includes meeting requirements like high net worth status and strong track records at established companies.
What are some differences between centralized and decentralized finance?
Centralized finance works the way it always has – you have a bank that you trust with your money, and they keep track of how much you owe them. The cryptocurrencies we’ve seen so far work similarly: You have a wallet or exchange where you store your funds. Whenever you want to send someone money, these wallets hold your private keys and serve as middlemen who let two people transact without directly sending funds from one person to another.
In contrast, decentralized finance works as an open network where anyone can own their funds or offer lending services without any restrictions. Instead of trusting third parties like exchanges or custodial wallets with your money, you take ownership over your funds using a non-custodial wallet or trustless lending service.
Because decentralized finance is built on open networks, it can lead to better security and transparency than traditional finance.
How does DeFi work?
Three components allow for DeFi services: smart contracts, cryptocurrencies, and blockchains. A smart contract, in simple terms, is computer code that executes some action when certain conditions are met – for example, transferring money from one person to another after an asset has been locked up as collateral on-chain. Cryptocurrencies like Ethereum allow people to transact with each other directly using these trustless programs because they can be sent back and forth without having to rely on a third party (like a bank or wallet) that could potentially go offline or abscond with your funds. Finally, blockchains are the underlying technology that makes this all possible. They provide an immutable public ledger where transactions can be recorded without any central authority, meaning there’s no way for anyone to change records ex post facto because they’re stored decentrally across many nodes.
What are some examples of DeFi services?
Decentralized finance allows people to do more than just store or transfer funds – it unlocks a whole new set of financial products that never existed before because these things have always required an intermediary to function. For example, if you want to borrow money from someone, how can you be sure they’ll pay you back after the fact? Using traditional finance requires trusting a third-party loan servicer or credit reporting institution with your information so they can keep track of your credit score and payment history. With decentralized finance, smart contracts are used instead – this means loans between peers don’t require any trust because they’re executed using computer code without an intermediary. In other words, you can get a loan from someone without worrying about them failing to repay you because the code executes automatically when all conditions have been met.
Why would you use decentralized finance instead of traditional finance?
Because DeFi services are open and accessible to anyone, there’s a lot more freedom to experiment with different financial products that people worldwide can use. You don’t have to live in a wealthy country or conform to strict KYC/AML requirements to receive access as a customer – you can download an app from the App Store and start using it without any barriers. All of this is already possible with traditional finance – but because these services are centralized, they come at a considerable cost: high fees, slow speeds, exposure to digital security threats like hacks and outages, and unfair policies that put the needs of the few above everyone else.
What is the future of DeFi?
The possibilities for decentralized finance to revolutionize how we access and manage money are endless. Because it can be used by everyone regardless of origin, wealth, or location, DeFi has the potential to help unbanked and underbanked communities break down barriers and gain financial sovereignty like never before. It also enables people to take greater control over their personal information and digital security because they don’t have to rely on centralized sources to handle it for them. On top of that, smart contracts allow people from different countries to transact with each other freely using cryptocurrency. No longer do you need to know someone in another country through a bank transfer (and pay exorbitant fees) as a prerequisite so that you can buy something online. Finally, decentralized finance can directly affect society because it allows people to create their own financial products that are accessible and open to everyone.