DeFi (decentralized finance) generally refers to Ethereum and its blockchain applications. Aiming to disrupt the current system of financial intermediaries, Ethereum is a major public blockchain. Instead of going through middlemen like banks or brokerages, DeFi can be used by anyone.
What is DeFi?
Unlike a bank or brokerage account, the use of DeFi does not require a government-issued ID, Social Security number, or proof of address. More specifically, DeFi refers to a system by which software written on blockchains makes it possible for buyers, sellers, lenders, and borrowers to interact peer-to-peer or with a strictly software-based middleman rather than a company or institution facilitating a transaction. DeFi places technology at the front and center of transactions in the financial services industry. Right now, DeFi addresses the issue of deposits through cross-chain operations and achieves leveraging through the margin system. At last, DeFi creates functions similar to credit derivatives.
Why DeFi is Important for Crypto Investors?
One of the most unique parts of DeFi is its constituent smart contracts, which power everything from programmable digital assets to decentralized applications (DApps). The social transformation from traditional finance to DeFi will constitute a fundamental change in how we interact with money. Smart contracts are publicly accessible and highly interoperable. So, like Lego pieces, projects in DeFi can easily connect to create powerful innovations.
Difference Between Defi and Traditional Finance
In traditional finance, a highly regulated sector, customers are often charged with huge service fees. In contrast, with DeFi, you can be more autonomous with your trades, which can be conducted without any permission or waiting. This makes transactions and fees more transparent.
Four Popular DeFi Applications to Know
In DeFi, there are already dozens of different financial applications. In the coming years, more such applications are bound to appear. Next, we will briefly introduce several types of DeFi applications.
Borrowing and lending
One of the most popular use cases of DeFi is borrowing and lending cryptocurrencies. In particular, lending is a stylish way to earn passive income in DeFi. Most loans made in DeFi are secured via smart contracts with more collateral than the borrowed value. This reduces the risk for lenders.
Decentralized exchanges (DEXes) are smart contracts that allow users to buy, sell, or trade cryptocurrencies or tokens. Because they run on the Ethereum blockchain, these exchanges operate without any central authority. Instead, smart contracts enforce the rules, execute trades, and securely handle funds when necessary. On a DEX, a higher trading volume means more frequent DeFi transactions, which is a good sign.
In mainstream finance, a derivative is a financial contract between two or more parties, the value of which is determined by the performance of a specific asset. On Ethereum, an endless variety of derivatives can be created and secured via smart contracts without the need for intermediaries. Derivatives are comparatively more complex and come in a great variety, including futures, options, leverage, etc. For instance, Synthetix is a popular DeFi derivatives project.
Tokenized assets and asset management is a quickly growing sector of DeFi. Existing financial assets deployed to the blockchain as tokens fit nicely into DeFi protocols, extending their utility.