Recently updated on October 25th, 2022 at 11:15 am
Decentralized Finance or DeFi is currently one of the hottest crypto sub-industries along with NFTs. They recently gained much attention because of influential A-listers like Mark Cuban and Elon Musk tweeting about them. So what is it? And why is it important? Here’s DeFi explained.
Decentralized finance is any activity that involves money operating on a platform. These platforms are called blockchains, and multiple servers usually back them. For many years, people have seen the flaws and corruption evident in CeFi (Centralized Finance). So people created DeFi protocols to eliminate such problems.
Several types of finances are currently centralized, such as banks, lending institutions and more. So what are some current types of DeFi projects that are now available?
- Transferring Money
- Margin trading
The best and most extensive decentralized system today is Bitcoin. It was created 12 years ago by someone under the pseudonym Satoshi Nakamoto. This person built the entire system of Bitcoin on a blockchain. A blockchain is a digital ledger that records the transactions and distributes this information across multiple servers and computers.
Image source: https://ethereum.org/
All the transactions are on this blockchain, and they will be there forever. In addition, the blockchain system makes Bitcoin nearly impossible to hack or change because multiple servers and computers are running it.
Blockchain technology has revolutionized decentralization. And now, hundreds of public and private blockchains have been created for different purposes.
As mentioned previously, there are several DeFi projects available in the market. Let’s take a look at them closely.
1. DeFi Lending and Borrowing
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Maker DAO is one of the first DeFi projects. And it started the DeFi lending and borrowing movement.
Another project is called Compound, and it is founded and maintained by Compound Labs. An open-source software development company initially built Compound for developers to unlock a universe of open financial institutions.
Finally, Aave is another open-source platform where users can participate as depositors or borrowers.
2. DeFi Crypto
There are several examples of DeFi crypto, such as:
DeFi crypto, also known as DeFi tokens, are made to recreate traditional financial services. These services include earning interest or taking out a loan. These are services usually provided by a bank or a lending or borrowing institution. So what’s different?
DeFi crypto makes these negotiations happen based on their computer code or smart contract. So what’s a smart contract, and how does it work?
Smart contracts are detailed instructions of a product. And only programmers can create these types of contracts. Moreover, these contracts are constant and consistent throughout, leaving very little room for error.
So, for example, if the smart contract says, “payout dividend when profit reaches a specific amount”,. You will receive a dividend payout whenever a certain amount is reached. There is no middle man in DeFi and everything. All the terms and conditions are already included in the DeFi.
Once the code is already written, it can already run by itself. Changes are not encouraged because all the changes will show on the Ethereum blockchain in multiple servers if anything gets changed.
3. DeFi Exchanges
There are several popular DeFi exchanges such as:
There are popular CeFi exchanges as well, such as:
So what are the benefits and risks of investing in decentralized exchange? For the benefits, it’s faster, cost-effective and globally accepted. But it has low liquidity, the interface is not user friendly, and there is no capital for insurance.
4. So with all the risks and benefits, is DeFi safe?
DeFi is relatively safe due to its smart contracts; however, since DeFi relies heavily on technology, bugs and errors along the way are inevitable. Furthermore, DeFi is still relatively new, so significant changes can still happen.
With the growing popularity of Decentralized Finance, it will continue to attract more users. And as more users are involved with DeFi, individuals and businesses may even shift to DeFi technology to take advantage of its benefits.