DeFi is the short form of Decentralized Finance. This term refers to a wide variety of financial applications in the blockchain or cryptocurrency domain for doing away with financial intermediaries.
What is DeFi?
Decentralized Finance or DeFi draws inspiration from blockchain and allows multiple entities to hold a copy of the history of transactions. This means that no single entity or central source controls the Decentralized Finance network or system. It is a revolutionary step in the financial space because it does away with the centralized systems and human gatekeepers, seen in the traditional financial world.
In the traditional financial system, human gatekeepers and centralized systems can significantly limit the sophistication and speed of transactions. In traditional finance, users have less direct control over their money. This is where DeFi is revolutionary. It expands the scope of blockchain from simply being used as a value of the transfer to more complex financial use cases.
If you are making a payment with a credit card, a financial institution works as an intermediary between you and the business. This institution has immense power over the transaction. It has the authority of pausing or stopping the transaction. The institution also keeps a record of the transaction in a private ledger. With the introduction of Bitcoin and other Decentralized Finance applications, their intermediary institutions are cut out of the picture.
What Are the Benefits of Decentralized Finance?
DeFi leverages the main principles of the Ethereum blockchain for:
- Increasing financial security and transparency
- Unlock liquidity and growth opportunities
- Support an economic system that is standardized and integratedz
The main advantages of the Decentralized Finance system are:
- Programmability: Smart contracts are highly programmable, which helps in automating execution. It also helps in creating new financial instruments as well as digital assets.
- Immutability: Data coordination can be done in a tamper-proof manner across the decentralized architecture of the blockchain, increasing both security and the ability to audit.
- Interoperability: The composable software stack of Ethereum ensures that the DeFi protocols, as well as apps, are built for integrating and complementing each other. Developers and product teams have more flexibility with the decentralized finance system. It helps in building on top of existing protocols, customizing interfaces, and integrating 3rd party applications. Decentralized Finance protocols are also called “money logos” for this reason only.
- Transparency: Other users on the network can verify every transaction on the public Ethereum blockchain. This high level of transparency around transaction data helps in a rich analysis of data and at the same time ensures the availability of network activity to all users.
- Open Source Code: The protocols of Ethereum and DeFi that run on the system are built with the help of open-source code. Anyone can view, audit, and build upon this open-source code.
- Permissionless: Decentralized Finance is defined by its open, permissionless access. The DeFi applications that are built on Ethereum can be accessed by anyone irrespective of geographical locations and minimum fund requirement. For access, you simply need a cryptocurrency wallet along with an internet connection.
- Self-Custody: The market participants of Decentralized Finance can always keep custody of their assets and also control their personal data through the use of Web3 wallets such as MetaMask for interacting with permissionless financial applications and protocols.
Decentralized Finance vs Traditional Finance
1. While the money is held by companies in traditional finance, money in a Decentralized Finance system is held by the user itself.
2. In traditional finance, you have to trust an intermediary company or entity on managing your money. Whether the company will lend to a risky borrower or not depends on that company’s discretion despite the fact that the money belongs to you. However, in the case of Decentralized Finance, you have complete control over where the money goes or where the money is spent.
3. As manual processes are involved, payments can take many days in the traditional system. However, in Decentralized Finance, the transfer of funds takes place almost instantaneously, within minutes.
4. While financial activity is intertwined with the identity of the user in traditional finance, it remains pseudonymous in DeFi.
5. While you’ve to apply for using financial services in a traditional system, it is completely open to everyone in a Decentralized Finance system.
6. Traditional markets have to be closed because employees need breaks. However, in the case of Decentralized Finance, the markets always remain open.
7. In Decentralized Finance, any user can take a look at the data of a product and also inspect how the DeFi system works. However, the financial institutions in the traditional financial world are closed books. You can never ask to check their loan history or record for managing assets, and others.
What can you do with Decentralized Finance?
Many things can be done with the help of decentralized finance protocols. Some of the most important ones are given below:
- Asset management
- Compliance and KYT
- Data applications and analytics
- Developer and infrastructure tooling
- Lending and borrowing
- Margin trading
- Prediction markets
- Synthetic assets
How to Invest in DeFi?
You can invest in DeFi by:
Top 6 Best DeFi Tokens to Buy
- Uniswap, 0x: decentralized exchange
- Aave: interest rate protocol
- MakerDAO: lending protocol
- Synthetix, UMA: Synthetic assets such as tokenized Tesla shares
- Yearn Finance: automated investing
- DAO: investment Decentralized Autonomous Organization
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