“Decentralized finance,” or “DeFi” for short, describes a wide range of cryptocurrency and blockchain-based financial applications with the overarching goal of upending the traditional financial services industry. Earning interest, borrowing, lending, purchasing insurance, trading derivatives, trading assets, and more are all possible with DeFi, but without the time and hassle often associated with banking. DeFi, like other forms of crypto, is universal, decentralized, anonymous, and accessible to everyone with an internet connection.
Is DeFi Useful?
DeFi uses the concept of Bitcoin, digital currency, and develops on it to provide a digital alternative to Wall Street that doesn’t have all the overhead (think office towers, trading floors, banker salaries). This has the ability to make it so that anybody with access to the internet may participate in free and fair financial markets.
What Are the Advantages?
- Easy: Available without application of any kind. Simply creating a wallet will get you access.
Pseudonymous: no need to tell your real name or email address.
- Cheap: you may relocate your assets whenever you choose without having to wait for transactions to complete or pay hefty fees.
- Rapid: Updated often (as often as every 15 seconds), and typically interest rates are substantially higher than standard Wall Street interest rates and awards.
- Completely open: the transactions may be tracked in detail (private corporations rarely grant that kind of transparency).
How Does It Function?
Dapps (short for “decentralized apps”) are the primary means by which users interact with DeFi; at present, the majority of these applications are built for and operate on the Ethereum network. There is no need to fill out paperwork or create an account as at a regular bank.
Examples of common uses for DeFi include:
Online exchanges, also known as decentralized exchanges (DEXs), allow users to trade one currency for another, such as US dollars for bitcoin or ether for DAI. Direct exchanges (DEXs) are becoming more popular because they eliminate the need for a trusted third party in cryptocurrency transactions.
Stablecoins are digital currencies whose value is pegged to a fiat currency such as the US dollar or the Euro.
In the case of lending platforms, smart contracts serve as an alternative to traditional middlemen in the form of financial institutions like banks.
Wrapped bitcoins (WBTC) are a form of transferring bitcoin to the Ethereum network that may then be utilized on the DeFi platform without any further conversions. Through the aforementioned decentralized lending services, WBTCs enable users to earn interest on the bitcoin they give out.
Prediction markets are places where people may wager on the results of future events, such as elections. DeFi iterations of prediction markets aim to provide the same features but without the need for any third-party aggregators.
In addition to these applications, additional DeFi ideas have emerged:
Yield farming: This trading strategy, known as “yield farming,” allows risk-taking investors to sift among a wide variety of DeFi tokens in search of those with the highest potential returns.
What we call “liquidity mining” occurs when DeFi apps provide free tokens to users in the hopes of luring them to their platform.
Composability: The source code for DeFi applications is freely available to anybody online. Since their code is modular, it may be used to “compose” new applications.
What Are the Drawbacks?
- Active trading on the Ethereum blockchain might become costly because to the fluctuating transaction rates.
- Given the immaturity of the technology, the value of your investment may change dramatically depending on the dapps you choose to employ and how you decide to put them to work.
- For tax reasons, you must keep your own records. Different jurisdictions may have different rules.