If you're involved in the crypto world in any capacity, chances are you've heard the term "decentralized finance" (often shortened to "DeFi") thrown around quite a bit. But what exactly is DeFi? In short, it's a financial system based on decentralized ledger technologies—the same kind of ledgers that power cryptocurrencies like Bitcoin. This system removes the control that banks and other financial institutions have over money, financial products, and services.
In this blog post, we'll give you a crash course in all things DeFi. We'll cover the basics of what DeFi is, how it works, and some of the most popular DeFi protocols currently available. By the end of this post, you should have a good understanding of what DeFi is and how it could potentially revolutionize the financial world as we know it.
What Is Decentralized Finance?
As we mentioned earlier, decentralized finance—often shortened to "DeFi"—is a financial system built on top of decentralized ledger technologies. These systems are designed to remove the control that banks and other financial institutions have over our money, financial products, and services. In essence, DeFi is about giving power back to the people.
DeFi protocols are built on blockchains like Ethereum. They use smart contracts to launch new financial products and services that anyone can access without having to go through a traditional bank or financial institution. Because these protocols are built on blockchain technology, they are inherently more secure than centralized systems. They also don't require trust in any one party—which means there's much less chance for fraud or corruption.
How Does Decentralized Finance Work?
With DeFi, anyone can create a financial product or service and offer it to the world without the need for a bank or other financial institution to act as a middleman. This not only makes the process easier and cheaper, but it also opens up a whole world of new possibilities.
For example, let's say you want to take out a loan. With traditional banking, you would have to go through a lengthy and complicated process with multiple middlemen involved. With DeFi, you can simply go to a lending platform, input the amount you want to borrow and the interest rate you're willing to pay, and have your loan funded almost instantly by another user who thinks the rate is fair to lend at.
The same goes for things like investing, trading, and even insurance. DeFi offers a wide range of new opportunities for both individuals and businesses alike.
Now that we know what DeFi is, let's take a closer look at how it works. Below, we'll outline some of the most popular DeFi protocols currently available and explain how they work:
MakerDAO: MakerDAO is a protocol that allows users to borrow Dai—a cryptocurrency that is pegged to the US dollar—using their Ethereum tokens as collateral. DAI can be used in any way that fiat currency can be used—it can be spent online or offline, exchanged for other currencies, or even used to earn interest through other protocols like Compound or Dharma Loan.
Compound: Compound is a protocol that allows users to borrow or lend Ethereum tokens in order to earn interest on their holdings. It's similar to MakerDAO in that respect, but it doesn't require collateral for loans—which makes it more accessible for users who don't own large amounts of ETH.
Dharma Loan: Dharma Loan is a protocol that allows users to take out loans in fiat currency using their cryptocurrency as collateral. Currently, Dharma Loan supports loans in USD, GBP, and EUR—and more fiat currencies are planned for the future. One of the unique things about Dharma Loan is that it allows users to lock up their crypto holdings for as short as one day or as long as three years. This gives borrowers much more flexibility when it comes to repaying their loans.
These are just a few of the most popular protocols currently available in the DeFi space. As you can see, each protocol offers something unique—whether it's lending in multiple fiat currencies or allowing users to take out short-term loans with flexible repayment terms.
Ultimately, what all these protocols have in common is that they're based on decentralized ledger technology—which means they're more secure than traditional centralized systems and don't require trust in any one party.
Advantages of DeFi
One of the biggest advantages of DeFi is that it's open to everyone. No matter where you live or how much money you have, you can access the same financial products and services as anyone else. That level of equality is unprecedented in the world of finance.
Another big advantage is that DeFi is built on blockchain technology, which makes it extremely secure. With traditional banking, your money is stored in centralized databases that are susceptible to hacking and fraud. But because blockchain is decentralized, your money is stored on thousands of computers all around the world—making it nearly impossible for hackers to get their hands on it.
What's more, blockchain provides transparency that simply doesn't exist with traditional banking. Every transaction that takes place on the blockchain is public and immutable, so you can always track where your money is going and be sure that everything is above board.
Decentralized finance (DeFi) is an intriguing new development in the world of finance—one that has the potential to upend the current system and put power back into the hands of everyday people. As we've seen, decentralized finance has the potential to offer a more democratic alternative to traditional banking. If you're interested in getting involved with DeFi, be sure to do your research and understand how it works before diving in headfirst.