What is decentralized finance? Decentralized finance or DeFi, is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. Decentralized finance eliminates intermediaries by allowing people, merchants, and businesses to conduct financial transactions through emerging technology. It is accomplished through peer-to-peer financial networks that use security protocols, connectivity, software, and hardware advancements. The system removes banks and institutions’ control over money, financial products, and financial services.
What Is Decentralized Finance?
DeFi is an umbrella term for public blockchain applications and projects aimed at disrupting the traditional finance world. Financial applications built on Blockchain technologies, typically using smart contracts, are referred to as DeFi. Smart contracts are enforceable agreements that can be executed without the use of intermediaries. Anyone with an internet connection can use them to conduct financial transactions and a variety of other tasks.
DeFi is made up of applications and peer-to-peer protocols built on decentralized blockchain networks with no access rights. Decentralized apps (dApps) are used to facilitate the lending, borrowing, and trading of financial tools. The Ethereum network is used to build the majority of DeFi applications today, but many alternative public networks are emerging that provide superior speed, scalability, security, and lower costs.
Some of the key attractions of DeFi for many people are that:
- It eliminates the fees that financial institutions charge for using the services.
- People hold money in a secure digital wallet instead of keeping it in an institution such as a bank.
- People can use the internet connection without needing approval.
- People can transfer funds in seconds and minutes.
A DeFi coin is like a digital version of a fiat coin. DeFi transfers the value of a financial transaction. DeFi coins are built on and often named for their unique, native blockchain networks. In spring 2021, Maker, Compound, Chainlink, and Ankr were among the most popular coins. Decentralized finance tokens provide crypto users with access to several bank-like services such as loans, lending, and insurance. DeFi tokens represent a diverse set of cryptocurrencies native to automated, decentralized platforms that operate using smart contracts.
These provide users access to financial applications and services built on the Blockchain. Defi tokens command a 114 billion U.S. dollar market cap, a relatively small proportion of the 1.7 trillion U.S. dollars cryptocurrency market. Defi has become one of the fastest-growing sectors in the industry, up from 89 billion U.S. dollars the previous year. Decentralized finance, or DeFi, uses emerging technology to remove third parties in financial transactions. The components of DeFi are stablecoins, software, and hardware that enables the development of applications. The infrastructure for DeFi and its regulation are still under development and debate.
In centralized finance, banks hold money, whose overarching goal is to make money. The financial institutions are full of third parties who facilitate money movement between other parties and charge fees for using their services. For example, suppose you purchase a gallon of oil using your credit card. The charge goes from the merchant to an acquiring bank, which forwards the card details to the credit card network.
The network clears the charge and requests a payment from your bank. The bank approves the charge and sends the approval to the network, through the acquiring bank, back to the merchant. Each entity in the chain receives payment for its services because merchants must pay for the ability to use credit and debit cards. All other financial transactions cost money, loan applications can take days to be approved, and customers might not even be able to use a bank’s services if they’re traveling.
Decentralized finance, or DeFi, manages financial transactions using cryptocurrency and blockchain technology. DeFi aims to democratize finance by replacing legacy, centralized institutions with peer-to-peer relationships capable of providing a full range of financial services, including everyday banking, loans, and mortgages, as well as complex contractual relationships and asset trading.