Decentralized finance, or DeFi, is about using technology to cut out the traditional banks and other institutions from financial transactions. It’s a collective term for open financial products and services typically built on blockchain technology like Ethereum.
Currently, DeFi is mostly about cryptocurrencies, but also NFTs and other replacements for traditional financial services. The idea is to create an interconnected system free from the interference of intermediaries such as central banks and governments. DeFi can be accessed by anyone with an internet connection and a browser or other app.
DeFi tokens give exposure to global financial markets and currency alternatives like cryptocurrencies. By making digital finance programmable, the individual gets increased control and visibility over their money.
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How DeFi Works
The DeFi revolution started with Bitcoin and specifically the idea behind the technology that underpins it – the blockchain. Blockchain technology (when implemented properly should be noted) can be trusted and relied on without being dependent on additional intermediaries.
Solutions like “smart contracts” are one example.
A smart contract essentially replaces the financial institution, such as a bank, giving the individual the power to hold and send funds, as well as issue refunds. Smart contracts are controlled by the respective community, meaning transactions can be publicly verified.
What Can You Do With It?
DeFi has created a unique, decentralized alternative to most financial services, opening up opportunities for new products. These are typically accessed through apps and platforms, such as Binance, that replace traditional money markets and offer retail products. Investors can speculate on Initial Coin Offerings (ICOs), for example, taking positions on emerging cryptocurrencies.
DeFi currently covers most services that a standard financial institution offers, including the secure sending and receiving of money, accessing currencies, borrowing, saving, investing, and earning interest through lending rates. However, due to its innovative technology, it also offers advantages over traditional finance, including lower costs and the frictionless streaming of money.
DeFi Vs Traditional Finance
| DeFi | Traditional Finance |
|---|---|
| You hold your money & control it | Your money is held by companies that could mishandle it |
| Accessible to anyone | Access & loans controlled by financial institutions |
| Markets open 24/7, 365 days a year | Opening times vary because employees need breaks and operate across different time-zones |
| Rapid transfers | Manual payments can take days to process |
| Reduced need to verify your identity | Access to products subject to extensive identity checks |
| Built on transparency | Private institutions with complex operating structures |
Advantages
DeFi projects overcome many of the issues presented by traditional financial institutions.
These centre around cryptocurrencies, arguably the future of finance, as demonstrated by the daily growth in market capitalization of leading altcoins.
Services that were previously slow and subject to human error are automated and safer.
The DeFi Pulse Index list highlights its inclusivity, with blockchain products lowering barriers to entry and exit, making digital money accessible to everyone.
The benefits are also regularly making news headlines, with people trading and loaning altcoins worth millions of dollars, without the need for personal identification.
Disadvantages
Trading on NFTs and cryptos comes with high levels of volatility and in turn, increased risk.
Also, bugs in smart contracts are still common with no ability for retrospective amends once secured using respective protocols.
Additionally, DeFi draws the financial system away from the interconnected legalities of global financial systems.
And any attempt to do this creates a series of protocol challenges, and until these are addressed, the scalability of DeFi is questionable.
Finally, DeFi typically relies upon blockchain applications, meaning it suffers from limited transaction throughput.
This means that transaction speeds can suffer as Ethereum networks, for example, can only process around 25 transactions per second, while Visa can process 24,000.
Adding to the confusion are crypto airdrops creating popularity where there is none, making it difficult to separate the good crypto stock from the bad.
Trading With DeFi
Popular cryptos within the DeFi space include Bitcoin, Litecoin and Ripple.