Decentralized finance, also known as DeFi, is an umbrella word for the part of the crypto world that’s focused on creating a new, internet-native financial system by replacing old intermediaries and trust mechanisms with blockchains.
It’s a new financial technology that uses secure distributed ledgers similar to cryptocurrencies. The system decentralizes authority over money, financial products, and financial services from banks and institutions.
How does DeFi work?
In the traditional financial system, intermediaries such as banks or stock exchanges are required to send or receive money. All parties must trust those intermediaries to act reasonably and honestly to feel comfortable doing the transaction.
These middlemen are replaced by the software in DeFi. People trade directly with one another instead of dealing by banks or trading platforms, with blockchain-based “smart contracts” creating markets, settling trades, and guaranteeing that the entire process is fair and trustworthy.
Here are some examples of how people are using DeFi today:
● Lending: Earn interest and rewards every minute rather than once a month by lending your bitcoin
● Obtaining a loan: Instantly get a loan without filling out paperwork, even for highly short-term “flash loans” that traditional financial institutions don’t give
● Trading: Make peer-to-peer crypto asset trades, just like you could buy and sell stocks without a brokerage
● Investing in the future: Put part of your cryptocurrency into alternative savings accounts to achieve better interest rates than you’d get from a bank
● Purchasing derivatives entails placing long or short wagers on specific assets. Consider them the cryptocurrency equivalent of stock options or futures contracts
Why DeFi?
DeFi expands on Bitcoin’s fundamental principle — digital money — to provide a completely digital alternative to Wall Street without the associated costs (think office towers, trading floors, banker salaries). This has the potential to build more open, accessible, and fair financial markets that anybody with an internet connection may access.
(written by Catherine S Thomas)
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