What is DeFi? | Decentralized Finance For Dummies

What is DeFi? | Decentralized Finance For Dummies

DeFi is now the hottest trend in the crypto space but atimes it can be confusing especially to beginners in the space. If you have been in the crypto space or have done anything crypto-related, you must have probably come across the term “DeFi”.

You might be wondering what is this Defi trend everyone is speaking about, trending almost on all the social media platforms? What is it all about? How is it going to improve the finance system? However, there is a lot to know when it comes to DeFi.

This guide will discuss the basic things you need to know to start your  “DeFi” journey.

What is Defi?

Generally, Cryptocurrency with the support of blockchain technology gives everyone access to manage and access their finances from anywhere around the globe.

Decentralized finance, simply DeFi is a broad system of financial applications built on the Internet that runs without the authority of any third party or intermediaries. “It’s an umbrella term for the part of the crypto universe.” according to The New York Times.

DeFi movement provides a transparent, permissionless, and open-source financial ecosystem. Here, the users maintain and manage their assets without the control of any prominent authority. DeFi could be valued as an alternative to the traditional financial system. 

The DeFi system is made up of lots of financial products which are non-custodial and decentralized, built on highly specialized and lucrative crypto projects that have caught the interest of investors including top companies.

Non-custodial means that the teams don’t have any control over your crypto assets. Using the DeFi protocol you can always manage and control your cryptocurrency all by yourself.

Decentralized means that the team behind these protocols doesn’t have power over the smart contracts. DeFi protocol creators vote themselves out of power to give the community control over the network. Users or investors are given the power to vote and decide on how to operate and manage the network. 

DeFi relies on smart contracts, blockchain, and cryptography to execute financial services, such as exchanges, loans, trading, and much more. Also, users interact with the defi ecosystem through peer-to-peer (P2P), decentralized applications (DApps), and decentralized exchanges (DEX).

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Decentralized Finance (DeFi) vs Centralized Finance

Comparing DeFi and CeFi is a nice way to understand DeFi. However, both systems function to manage people’s money and execute transactions but they run differently. 

In the Centralized Finance System, assets are managed by firms while in the Decentralized Finance System, assets are managed by smart protocols. The most notable difference between DeFi and Traditional finance is control and accessibility to users.

In Defi, users can personally access their assets and carry out transactions directly using the smart contracts but in CeFi, most of the financial services offered require companies to manage assets and intermediaries to carry out transactions.

Like in CeFi where your identity and Know Your Customer(KYC) checks must be completed before you can access any CeFi service, In DeFi there is no requirement for sign-ups, identity checks, or any other condition required before you can access the service. All you need to access the DeFi service is to create a wallet and fund it with some crypto. 

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DeFi Use Cases

In addition to the myriad applications of blockchain technology and smart contracts, decentralized finance (DeFi) applications are among the most popular use cases of Ethereum.

Lending and Borrowing

The most popular DeFi applications are decentralized exchanges, synthetic assets, and lending platforms.

A decentralized exchange is an exchange that does not rely on a third party to hold the customer’s funds. Instead, trades occur directly between users (peer-to-peer) through an automated process. The best-known decentralized exchanges that run on Ethereum’s blockchain are Uniswap and Sushiswap.

Lending platforms allow users to lend and borrow assets. The borrower pays interest to the lender, and the interest is used to cover the risk of default. The best-known lending platforms are Maker and Compound.

Ethereum 2.0

Ethereum’s DeFi applications have attracted billions of dollars in value. In the process, they have created an ecosystem of decentralized applications that can interact with each other. This ecosystem is known as the “DeFi ecosystem.”

Ethereum 2.0 is a major upgrade to the Ethereum network that is currently in development. The upgrade is designed to improve Ethereum’s scalability, security, and sustainability.

The most anticipated feature of Ethereum 2.0 is “sharding,” which is a method of scaling a blockchain by dividing it into multiple “shards.” Each shard is a separate blockchain that processes a portion of the overall transaction volume.

Sharding is a major improvement over the current “proof-of-work” consensus algorithm, which can only process a limited number of transactions per second. With sharding, Ethereum will be able to process thousands of transactions per second.

In addition to sharding, Ethereum 2.0 will also implement “staking,” which is a method of securing the network that does not require energy-intensive “mining.” Under staking, users can lock up their ETH in return for a share of the transaction fees.

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Margin and Leverage

Leverage is one of the features common in cryptocurrency trading. Margin and leverage is a component in Defi which allows users to borrow cryptocurrency using other crypto assets as collateral.

In margin trading, borrowed funds are used to increase the potential gains of a certain asset. Traders use leverage to increase their positions in the market. With Defi, traders don’t need to depend on agents to borrow funds, rather they could borrow funds by employing smart contracts.

Stablecoins

Stablecoins are cryptocurrencies with the same stable price as fiat currency. These crypto-assets are pegged to a real-world asset like the US dollar. As cryptocurrencies are highly volatile which means they could gain or lose value in seconds.

As a result, stablecoins were adopted as a reliable digital currency with less volatility which can be used at any time. Stablecoins are not controlled or issued by any central authority.

Insurance

Insurance is a powerful use case for DeFi applications. It allows companies, communities, and individuals to protect themselves against loss or unforeseen events. In the traditional financial system, insurance contracts are often complex and opaque.

This makes it difficult for consumers to understand what they’re buying and limits their ability to compare different policies.

With DeFi insurance, policies are stored on the blockchain and can be easily compared. This transparency reduces the risk of fraud and allows consumers to make informed decisions. In addition, DeFi insurance can be automated using smart contracts. This means that claims can be processed quickly and efficiently, without the need for human intervention.

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What are the Advantages of DeFi?

There are many advantages to using DeFi protocols, including:

#1. Security

DeFi protocols often offer increased security compared to traditional financial services. For example, many DeFi protocols are built on Ethereum, which uses smart contracts to enforce the terms of a contract. This means that there is no need for a central authority to manage or oversee the contract.

#2. Transparency

DeFi protocols often offer increased transparency compared to traditional financial services. This is because all transactions are recorded on a public blockchain, which allows anyone to view the transaction history.

#3. Increased access

DeFi protocols often offer increased access to financial services. This is because they are often available 24/7 and do not require a bank account or credit score.

#4. Profitability

DeFi protocols often offer increased profitability compared to traditional financial services. This is because they often offer higher interest rates on deposits and loans.

Conclusion

DeFi creates a system where people can freely manage their finances with little or no risk of mismanagement. The system enables users to control their assets and execute transactions without intermediaries or any central authority.

It is seen to have a strong stance in the Financial system with lots of benefits it has in stock for everyone in the space.

Hope with this article, you get to understand the basics things you need to know when starting your DeFi journey. If you have any questions please let us know in the comment section.

About Vincentia Ahuzi

Ahuzi Vincentia is a Crypto content creator and an ardent writer. She is passionate about research and self-growth.

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