What is Decentralized Finance? Everything you need to know about DeFi basics
For a long time, global financial systems have been largely centralized. Traditional finance has relied on centralized entities such as banks act as an intermediary, courts settle disputes, Governments to provide regulation, and so on.
As such, financial data is not publicly visible to everyone, and financial assets are controlled by entities that transact in them based on end user instructions.
In recent years, a new type of financing – which has no central authority and gives end users full control over their assets – has emerged.
Known as Decentralized finance (DeFi), this type of financial system includes financial applications built on blockchain networks.
As blockchains are public and open source, DeFi is a transparent and unauthorized way for users to directly interact with each other in peer-to-peer networks. In a way, the code or software governing the blockchain acts as an intermediary, and since blockchains run on distributed nodes, there is no singular point of failure present in DeFi.
How DeFi Works
In traditional finance, a financial institution’s firewalls can be compromised and funds can be lost in a hack. Or the institution can close. In DeFi, Decentralized applications (DApps) running on a blockchain network continues to operate even if few or more nodes in the chain go offline.
As a result of this lack of central authority, users are not required to enter their government credentials, email address, address, or contact details to use DeFi.
Instead, users create a password when setting up blockchain-enabled wallets like MetaMask Where Trusted portfolio. They also get custody of a 12 word start sentence to recover his account. During these steps, users do not share any personal information about them.
Once their wallets are set up, users can acquire cryptocurrencies from exchanges such as CoinDCX, WazirX, CoinSwitch Kuber, Coinbase, Binance, etc. and remove the coins from their wallet. Once their wallets contain crypto, users can start using DeFi.
In the DeFi ecosystem, users can explore options for borrowing and lending, yield farming (providing liquidity in exchange for rewards), trading on decentralized exchanges / markets, crypto banking, and more. Moreover.
Smart contracts and the DeFi stack
Ethereum (ETH) is the blockchain network at the head of the DeFi space and most DeFi applications are built on Ethereum. Indeed, Ethereum has brought significant value to users through its smart contracts, which are pieces of code that run automatically when certain conditions are met.
They are basically contracts that enforce the agreements between the parties. In DeFi, they act like financial contracts containing terms written in computer code.
For example, if a user wishes to withdraw ETH from a decentralized exchange to their wallet, a smart contract allows reliable and automatic execution of the transaction, and does not require manual supervision.
A four-layer stack enables transactions in DeFi. These are the settlement layer (base layer like Ethereum), the protocol layer (standards and rules governing transactions), the application layer (applications and services intended for consumers), and the d. ‘aggregation (aggregators connecting DApps).
DeFi: The future of finance?
Users are increasingly interested in DeFi because it offers full control over its assets, eliminates singular points of failure, resists censorship or closure, and democratizes access to financial services.
In 2021, the value of the assets used in DeFi touched $ 100 billion for the first time, according to DeFi Pulse The data. Some of the main DeFi applications include UniSwap, SushiSwap, Curve, Compound, dYdX, Aave, and more.
Despite the benefits, the DeFi industry is still in its infancy and faces many challenges.
These included poor performance (blockchains are inherently slower than centralized networks), bad user experience (The DeFi ecosystem is cluttered with many options and DApps are often not intuitive or easy to use), a high risk of user error, and occasionally swindle.
The global, transparent and open source nature of DeFi also poses challenges to existing financial regulations in all countries. This is because countries generally develop regulations based on the idea that nations are separate financial jurisdictions.
Billionaire investor Mark Cuban is bullish on DeFi and believes it will pose a big challenge for traditional banks. But he admits DeFi won’t automatically end the bank. CoinDCX co-founder and CEO Sumit Gupta also argues that DeFi won’t make banks entirely obsolete, but banks will find a way to integrate DeFi into their systems and achieve coexistence.
As major banks around the world take note of DeFi and its potential to disrupt traditional finance, it remains to be seen how the future of finance plays out.