Decentralized finance, or DeFi, is a method of receiving, using, distributing, and storing money that uses the blockchain to eliminate intermediaries. DeFi is a global, anonymous, peer-to-peer (i.e., not via a centralized system) financial ecosystem that is open to all.

What Exactly Is DeFi?

DeFi is built on blockchain technology, which allows for the simultaneous storage of multiple copies of a transaction without any organization’s ability to control or alter it. DeFi is unique because it takes blockchain beyond simple value transfer to more complex financial use cases. Formally, you become your bank because you can freely duplicate its services in lending, borrowing funds, insurance, and trading in assets and derivatives without having to fill out voluminous paperwork.

DeFi vs. Traditional Finance

Consider the most insignificant aspect of your daily routine. For example, you eat lunch at the same cafe every day because the food is so good. Your credit card will be charged for this meal. But have you ever thought about paying an intermediary, the bank, rather than the business? If the latter objects to or suspects something, your payment will be rejected or reviewed in a specific order, as will your entire banking history (you just had lunch, right?).

What if you sent a “serious” money transfer to another continent instead of a frivolous dinner? If time is of the essence, in this case, the last thing you want to hear is “the transfer will take several banking days.”

On the other hand, centralized financial institutions are concerned with more than just direct purchases. It is valid for:

• Loans
• Insurance
• Crowdfunding
• Rates
• Securities

DeFi eliminates this inconvenience. You pay directly from your wallet to the counterparty’s wallet for any product or service. Furthermore, some forward-thinking businesses have begun to pay employees in cryptocurrency.

The blockchain technology market is expected to reach nearly $70 billion by 2026, according to MarketsandMarkets.

Also Read: Blockchain Enterprise: Use Cases and How it Differs from Others

How Does It Work?

DeFi builds on Bitcoin’s core premise of digital currency to create an entirely digital alternative to stock exchanges. However, multi-story, opulent office buildings are not required in this area. It is sufficient to have a device that can connect to the Internet. As a result, DeFi supporters continue to advocate for open, accessible, and equitable financial markets that are open to all.

DeFi provides financial services without intermediaries by utilizing cryptocurrencies and smart contracts. Users typically interact with DeFi through software known as dApps (“decentralized applications”), which are primarily run on the Ethereum blockchain.

In a DeFi transaction, a smart contract replaces a financial institution. Under certain conditions, a smart contract is a type of Ethereum account that can store and send/refund funds. This smart contract cannot be changed while active; it will always work as intended. Contracts are also open to the public for inspection and auditing. This means that bad contracts are frequently and quickly scrutinized by the community.

Due to the open-source nature of DeFi, users can theoretically test and innovate on the protocols and applications. As a result, individuals can mix and match protocols to create unique combinations of possibilities when developing decentralized applications.

Pros and Cons of DeFi

Any innovative technology is intended to improve people’s quality of life and make their lives easier. DeFi appears to be a very appealing concept with untapped potential from this vantage point. Despite this, every innovation has flaws and a human component. Let’s look at the benefits and drawbacks of DeFi.

Among the advantages are:

• Transactions are free of middlemen (a plus both in terms of security and the financial side)
• Obtaining a loan without the “burden” of a credit history
• Interest rates have risen as a result of market dynamics.

Disadvantages of DeFi

• If you forget your password after answering your mother’s maiden name question, you may lose your assets if no governing body can be contacted to request a password reset.
• Yes, you can get a loan without worrying about revealing your credit history. Nonetheless, you are denied the protection of your consumer rights.
• Yes, high-interest rates can make you a lot of money, but there are always risks associated with high volatility.

DeFi Examples

The following are the most common (but by no means exclusive) types of DeFi:

• Stablecoins
• Lending marketplaces
• Decentralized Exchanges (DEX)
• Market forecasting

What makes DeFi different from Bitcoin?

DeFi refers to financial services built on public blockchains such as Bitcoin and Ethereum. Bitcoin is a decentralized digital currency that runs on its blockchain and serves primarily as a store of value. They enable users to earn interest or borrow against their crypto assets.

DeFi includes various financial services-related applications, such as trading, borrowing, lending, and derivatives.

DeFi and Ethereum

Ethereum is discussed in this context not as a cryptocurrency but as a platform for developing DeFi applications. Most applications are written on Ethereum because it is considered the most manageable platform for developing decentralized applications. As a result, you can borrow tokens from one website and exchange them for interest tokens from another market and application. They are everywhere. This is similar to withdrawing money from a “foreign bank” when your home bank is not nearby.

DeFi on Ethereum comprises assets, protocols (smart contacts), and applications that power the protocols.

What Is the Purpose of DeFi?

In addition to the absolute freedom of transactions in peer-to-peer trading, as previously discussed, you can create ideal conditions for passive income by lending to others and earning interest on loans. Tokenized versions of investments, such as stocks, funds, and NFTs, can also be traded.

DeFi can also be viewed as a long-term benefit because it allows you to invest a portion of your cryptocurrency in alternative savings accounts and earn higher interest rates than a traditional bank.

Why is DeFi so important?

However, keep in mind that investing in DeFi is a risky venture. Approximately $2.2 billion was stolen directly from DeFi protocols in 2021. Furthermore, many scammers used plausible pretexts for theft, imitating the site’s “security,” in which unsuspecting cryptocurrency investors put their trust. If you or your financial advisor lack sufficient knowledge of the subject, investing in something more stable is best.

Decentralized finance is still in its early stages of development. First, infrastructure failures, hacks, and scams continue to plague the ecosystem because it is unregulated. System stability, energy requirements, carbon footprint, system maintenance and upgrades, and hardware failures are among the other issues.

However, you can only make a good profit and, if you’re lucky, gain global recognition if you stay on the cutting edge of business, understand all the trends, and effectively implement them. It is time to create a DeFi application when the dApps market is not yet saturated. Get started by hiring a reputable defi token development company.