What is Decentralized Finance: (DEFI)
Introduction:
A centralized system oversees nearly all aspects of finance, lending, and trading today, which are governed by various banking and financial authorities.
Every financial service, from auto loans to mortgages to investing in stocks and bonds, requires regular consumers to deal with financial middlemen.
A financial transaction cannot be bypassed if banks, exchanges, and lenders earn a percentage of the profit from the transaction.
Because of this, consumers have a difficult time directly accessing financial services. So, what is decentralized finance? How does it remove the middleman and ease our transaction processes?
What is Decentralized Finance:
Decentralized finance is the idea of managing money without large institutions or corporations.
It is established through peer-to-peer transactions, which means that more of the work done by banks and other financial institutions is taken up by individuals.
Decentralized finance is based on Blockchain technology which has enabled financial applications and protocols with programmable functionality.
Transactions on the blockchain are carried out automatically by smart contracts that include deal agreements.
Only 5% of the crypto space is devoted to decentralized finance, according to CoinGecko, but it has seen rising growth in recent years. In June 2021, DeFi assets were valued at $93 billion, up from $4 billion three years earlier.
How does DeFi work?
To function, a finance system must have two key components: a platform on which to operate and a currency with which to do so.
Financial institutions serve as infrastructure in a centralized system, while fiat currency, like the US dollar, serves as currency.
For a full range of financial services to be offered, decentralized finance must replace these components.
Infrastructure:
The Ethereum platform allows developers to write decentralized programs. Their smart contracts can now be created through Ethereum, a code that can be automated for a number of purposes to manage financial services.
You can define how a financial service will operate through smart contracts, and Ethereum can implement the rules. Smart contracts cannot be changed once they have been deployed.
Currency:
Creating a decentralized financial system that is reliable and secure requires a stable currency. Ethereum’s own programmable cryptocurrency is highly volatile, and Bitcoin is incompatible with Ethereum, and Ether cannot be used to buy or sell on the Ethereum network.
Stablecoins are cryptocurrencies whose value is linked to a fiat currency.
Dai ( or DAI) is a stablecoin cryptocurrency which aims to keep its value as close to one United States dollar (USD).
The DAI stable coin is pegged in price to the US dollar – 1 DAI equals $1 USD. DAI is not backed directly by US dollar reserves but rather by cryptocurrency collateral. A decentralized currency like DAI is ideal for decentralized finance due to its stability.
What Are the Benefits of Decentralized Finance?
Blockchain technology provides decentralized finance, which increases financial security and transparency, unlocks liquidity and growth possibilities, and supports an integrated and standard economic system.
- Programmability
Smart contracts allow the creation of new financial instruments and digital assets and automate the execution of these contracts.
- Interoperability
Using DeFi, developers and product teams can combine established protocols with multiple custom interfaces, as well as integrate third-party applications. As a result, DeFi protocols are sometimes referred to as “money legos.”
- Transparency
A public blockchain broadcasts all transactions for other users to verify. In addition to allowing for rich data analysis, this level of transparency surrounding transaction data also ensures that network activity is publicly accessible.
DeFi protocols are also part of Ethereum, and the code for them is available to anyone who is interested in viewing, auditing, and building upon it.
- Permissionless
A key characteristic of DeFi over traditional finance is its permissionless, open access: anyone with a crypto wallet and access to the Internet, regardless of geography, is usually able to access applications built on Ethereum with a minimum amount of funds.
- Self-Custody
Participants in the DeFi market always keep custody of their assets and control of their private data because they use Web wallets in conjunction with permissionless financial applications and protocols.
DeFi is based on open-source technology. This allows everyone to access the financial using internal connect and apps.
With DeFi market are always open (24/7). There are no centralized authorities who can deny or block access to any product/services. So, DeFi aims to remove the intermediaries between parties in financial transaction
Key Layers of DeFi stack:
- Settlement Layer: This the base layer upon which other DeFi transactions are built. It consists of a public blockchain and its native digital currency or cryptocurrency. One example of the settlement layer is Ethereum. It’s native token is ether (ETH), which is traded at crypto exchanges. This layer can also have tokenized versions of assets, such as the U.S. dollar or gold etc.
2. Protocol Layer: Protocols are set of principles and rules that all participants in that eco-system have agreed to follow.
These are standards and rules written to govern specific tasks or activities. DeFi protocols are interoperable, meaning they can be used by multiple entities at the same time to build a service or an app.
One example of a DeFi protocol is Synthetix, a derivatives trading protocol on Ethereum. It is used to create synthetic versions of real-world assets.
Other DeFi protocols are ‘Aave’. ‘yEarn’, ‘Curve’ ‘Compound’ & ‘Project Serum’.
- Application Layer: Here, consumer-facing applications reside. These applications abstract underlying protocols into simple consumer-focused services.
4. Aggregation Layer: This consists of aggregators who connect various applications from the previous layer to provide a service to customers.
Final Thoughts
What is Decentralized Finance – Defi ?
Decentralized finance is a term that signifies a system that is interconnected with a blockchain-enabled, decentralized, and immutable ledger.
Defi refers to financial services using smart contracts which are automated enforceable agreements (which don’t need intermediaries like a bank or lawyer) and use online blockchain technology instead.
The Decentralized Finance network is a disruptive technology for organizations and individuals in the finance industry. The evolution of decentralized finance is a reflection of the disruption happening in every sector of society.
Decentralized finance utilizes blockchain technology to build a trustless system where intermediaries are no longer needed. This system promotes transparency and accountability with data hosted on a decentralized database. This database is highly secure through the use of cryptography and erases the need for an institution, such as a bank or broker, to verify transactions.
