We will explain what (DeFi) is and how it works in this beginner’s guide to decentralised finance. Traditional finance is already in the process of evolving. As a result, you can make your money work for you rather than against you. A new term has emerged in the world of Distributed Ledger Technology (DLT) in recent years known as DeFi.
What is DeFi and How Does it Work?
DeFi is a network of DApps (decentralised applications) and smart contracts built on the Ethereum blockchain that focuses on financial applications like loans, derivatives, exchanges, trading, and more.
DeFi focuses on the idea of “Lego” money. That is, anyone should be able to freely create, modify, mix, connect, or build on top of any DeFi product. Because DeFi protocols are modular, they can interact with one another (much like Lego constructors) to create an increasingly dense system of interacting parts. DeFi applications can be created by anyone who can write a smart contract.
What are the benefits of decentralized finance (DeFi)?
Traditional banks are administratively heavy and costly to run. Transactions take time and have forced many people out of the financial system due to their stringent rules and requirements.
DeFi arrived to resolve many of these issues. Some of its advantages include:
DeFi welcomes all participants in the financial system, regardless of pay, race, culture, wealth, or geographic location. Each user only needs a smartphone or computer with internet access.
Developers can freely build on top of existing protocols, customise interfaces, and integrate third-party apps with decentralised accounts. DeFi conventions are often referred to as ‘Money Legos’ due to their adaptability. Consolidating other DeFi products allows for the creation of new decentralised money applications.
DeFi enables a higher level of openness and accessibility. Because most DeFi protocols are built on the blockchain, all exercises are open to the public. Anyone can view transactions, but unlike traditional banks, these records are not directly associated with anyone.
DeFi platforms allow you to maintain control over your funds and finances. While you must store your assets on the platform, you have control over what happens to them. Rather than relying on human intermediaries to qualify you for a loan and manage your investments, a smart agreement does it all.
Nobody has the authority to prevent you from using the DeFi protocol. The smart contract that underpins it is a law that applies to everyone.
The DeFi environment provides viable opportunities for DeFi service and product development and innovation. DeFi is an open protocol that can be very useful in ushering in a new era of financial solutions. The importance of DeFi grows as it can use Ethereum and allows trailblazers to create new decentralised financial applications.
Decentralized Finance (DeFi) vs. Centralized Finance (CeFi):
In the traditional world, financial institutions are used to store money, borrow capital, earn interest, send transactions, and so on. Commercial banks have a long and proven track record of success. Commercial banks can offer insurance and security measures to deter and protect against theft.
On the other hand, such institutions hold and control your assets to some extent. Banking hours limit specific actions, and transactions can be time-consuming, necessitating back-end settlement. Furthermore, commercial banks require specific customer information and identification documents to participate.
What can you do with DeFi?
DeFi is increasingly being used in both simple and complex financial transactions. It is powered by decentralised apps known as “dapps” or other programmes known as “protocols.” Dapps and protocols process transactions in the two most popular cryptocurrencies, Bitcoin (BTC) and Ethereum (ETH) (ETH).
While Bitcoin is the more popular cryptocurrency, Ethereum is much more adaptable to a broader range of uses, so Ethereum-based code is used in much of the dapp and protocol landscape.
Traditional financial transactions: DeFi is already used for payments, trading securities and insurance, as well as lending and borrowing.
Decentralized exchanges (DEXs): Most cryptocurrency investors currently use centralised exchanges such as Carret. DEXs allow users to keep control of their money while facilitating peer-to-peer financial transactions.
E-wallets: DeFi developers are working on digital wallets that can function independently of the largest cryptocurrency exchanges and provide investors with access to everything from cryptocurrency to blockchain-based games.
Yield harvesting: DeFi, dubbed the “rocket fuel” of crypto, allows speculative investors to lend crypto and potentially reap large rewards when the proprietary coins paid by DeFi borrowing platforms for agreeing to the loan appreciate rapidly.
Non-fungible tokens (NFTs): NFTs turn non-tradable assets like slam dunk videos and the first tweet on Twitter into digital assets. NFTs make the previously uncommodifiable commodifiable.
The Future of DeFi
Crypto is the most recent digital offering from an industry that has existed since the dawn of time. Every financial service we use today under the fiat scheme will be rebuilt in the DeFi and open finance ecosystems in the coming years.
The first generation of Defi apps relies heavily on collateral as a safeguard mechanism, which means you must own crypto and then offer it up as collateral for borrowing more crypto.
We can also expect crypto wallets to become the hub for all digital asset activities in the future. Consider it a dashboard that not only displays your assets but also how much of them are locked up in various open finance protocols such as pools, loans, and insurance contracts.
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