What is DeFi? Guide to Decentralized Finance

You are likely to have heard of decentralized finance (DeFi) or even invested in some of the many top protocol projects in the sector. This is because the sector has grown exponentially within the past couple of years, with DeFi Pulse data showing that the total value locked (TVL) in DeFi projects rose by over 2,000% between May and December 2020. In this article we look at what DeFi is and its future within the crypto space.

What Does Decentralized Finance Mean?

Decentralized finance refers to the practice of making financial products available on decentralized blockchains for the public. What is DeFi? As indicated before, it refers to the same thing (decentralized finance).
To use DeFi, you don’t need a social security number, government-issued ID, or proof of address.
A network of individuals who work remotely approve transactions by solving complex mathematical equations. Network consensus voting can also do this.

DeFi vs Traditional Finance

Let’s define traditional finance first. Traditional finance (TradFi) refers to the centralized financial system that operates on fiat. The term “fiat” originates from a Latin word that means “let it be done.”

Now, what are the main differences? Here are the three primary differences between DeFi and traditional finance:

• A public blockchain is the trust-source in decentralized finance. On the other hand, central governance systems, which consist of licensed institutions and laws that govern all traditional finance activities, act as the source of trust.
• Decentralized finance is more open and transparent, which is the main reason it continues to gain traction. There are no barriers to entry. So, any programmer can fully take part in building unique financial systems on the blockchain.
• On the contrary, traditional finance is characterized by a high number of barriers. For example, it’s the sole duty of central banks to manage the production of new currencies. Besides, you must obtain proper authorization and licenses from regulators to operate as a payment service provider.

Which one is better, decentralized finance or traditional finance? DeFi stands out since it can eliminate the present-day’s financial bureaucracy.

How Do DeFi Protocols Work?

DeFi protocols or decentralized applications (dApps) require a decentralized infrastructure to run on and meet users’ diverse needs.

Most of them operate on the Ethereum blockchain. Some have migrated to blockchains that offer more scalability and speed.

The open-source software leverages blockchain and gives the owners a chance to control their data.

What Does DeFi Offer?

DeFi offers you the opportunity to trade thousands of coins on different blockchains. Once you’ve chosen a leading decentralized exchange like Uniswap, you can use these assets whenever you want. The DeFi version is comparable to using a currency exchange when traveling across different international boundaries. However, the technology guarantees that someone will always be available to approve trades, so it never closes.

DeFi gives you two ways to borrow money. These are:
Peer-to-Peer: Borrowers request and get loans from specific lenders Pool-Based: It’s also known as crowdfunding and involves lenders providing funds that individuals can borrow Everyone also has the right to become a lender on DeFi platforms. The lending platforms guarantee high-interest rates. Check with your DeFi platform for lender-specific qualifications and the terms and conditions.

DeFi offers knowledgeable traders an opportunity to lock up or stake their coins in smart contracts for rewards. These benefits can be in the form of a governance token, a percentage of transaction fees, interest from lenders, and the likes.

Stablecoins are used in the DeFi space to protect transactions when remitting payments, lending and borrowing money, and more. The coins are pegged in a stable asset or pool of assets like gold and fiat. They were designed to reduce the volatility of cryptocurrencies.

“Wrapped” Bitcoins is an innovation that brings Bitcoins to the Ethereum blockchain. In short, it helps to bring Bitcoin’sBitcoin’s price into play when investing or trading on decentral finance platforms. Each Wrapped Bitcoin (wBTC) is an ERC-20 token and represents BTC on a 1:1 ratio.

In the DeFi space, programmers can direct many activities to work together in several ways. For example, they can design an action to take place before, after, and parallel to another activity. With DeFi, users have the opportunity to choose tools that give them the most financial freedom.

DeFi allows users to buy or sell various financial products without affecting their price. Besides, it provides data that you can rely on to predict market trends. This makes the crypto industry a reliable crypto trading market.

What’s The Future of DeFi?

DeFi’s performance for the last year has put the cryptocurrency market on notice. Locked cryptocurrencies are steadily increasing in value. Some traditional cryptocurrency companies are also intending to cash in on the hype. The positive performance in the last few months is a solid indicator of the possible success of DeFi cryptocurrency.

Another possible pointer to the success of decentralized finance is innovative and revolutionary. The best DeFi platforms remove traditional barriers to accessing financial services. The World Bank approximates that close to 1.7 billion people lack access to financial services worldwide. De-Fi also gives more people the power to protect their wealth. Some governments enact rules that limit the rights of individuals to manage their resources. However, they lack control over DeFi crypto.
Other important common uses of DeFi that makes it stand out are:

• Borrowing and lending
• Decentralization of exchanges and marketplaces
• Creating reliable banking services like stablecoin insurance

Despite the great features and the increasing adoption of DeFi, a few drawbacks mean the future might present with some uncertainty. The boom attracted malicious actors. In 2020, DeFi thefts led to the loss of over $100 million. In the second half of the same year, close to half of crypto thefts were attributed to DeFi protocols.
Thieves also used decentralized exchanges to steal approximately $19 million from centralized exchange KuCoin.

Conclusion

As you might have noted, it’s evident that the DeFi industry has great potential and could be a major crypto sector. However, while it promises a lot, it faxes and experiences the same difficulties as the rest of the cryptocurrency space. Besides being in its infancy stage, the sector might be prone to serious security risks, including hacking and exit scams. It is such concerns that have regulators and governments across the world keen on the projects in this space.