Beginner’s Guide to Decentralized Finance (DeFi)

 

Decentralized finance (DeFi) is a variety of financial applications that are built using blockchain technology. More specifically, decentralized finance can also be referred to as a movement that focuses on providing an open-source, permissionless, and transparent financial system that is available to everyone and can operate without the need for any central authority.

With DeFi, users can have full control over their assets and interact with the system through peer-to-peer (P2P) and decentralized applications (dApps). The core feature of decentralized finance is its accessibility, even to those who are isolated by the current financial system. Another benefit of DeFi is the modular framework it is built upon. These interoperable DeFi applications on public blockchains will potentially create new financial markets, services, and products. 

 

What are the main advantages of decentralized finance?

With traditional finance, users rely on centralized institutions such as banks to act as intermediaries when using financial services. DeFi applications do not use any intermediaries. The apps are able to resolve every possible dispute, which makes users have control over their funds at all times. Because of this, the costs associated with providing and using these products are reduced, which allows for a more frictionless financial system. 

Since these new financial services are created on the blockchain, single points of failure are eliminated. All the data is recorded on the blockchain and sent to different nodes, making it hard to potentially shut down a service or hack a system. The frameworks for DeFi applications are built in advance, that’s why deploying one becomes less complicated but more secure. 

Another crucial advantage of an open system is its accessibility allowing individuals who don’t have access to any financial service to have access to it. Because the traditional financial system relies on the intermediaries making a profit, they don’t usually offer their services on locations with low-income communities. With the use of decentralized finance, the costs of financial services are significantly reduced, creating access to low-income individuals allowing them to benefit from a broader range of financial services.  

The potential use cases of decentralized finance

There are several use cases of decentralized finance. Here are some of them: 

Cryptocurrency

According to a report published by Jenco, a decentralized financial service platform, “digital assets, usually in the form of cryptocurrencies like BitCoin and Ethereum, are used by computer networks all over the world. These digital assets are made secure by using a method called cryptography that prevents double-spending and counterfeiting.”

“The blockchain, a ledger that is distributed and enforced by a separate web of computers, guarantees these cryptocurrencies’ integrity. One of the most distinctive traits of these digital assets is that they are not — and can not — be manipulated or controlled by any centralized authority.”

Borrowing and Lending

Open lending protocols, such as Jenco, are one of the most popular types of applications that are offered in the decentralized finance system. There are many advantages of an open, decentralized borrowing, and lending over the traditional credit system. These advantages include no credit checks, the ability to collateralize digital assets, instant settlement of transactions, and potential standardization in the future. 

These lending services are built on public blockchains, they reduce the amount of trust needed and have the assurance of cryptographic verification methods. Lending applications on the blockchain reduces counterparty risk, makes borrowing and lending faster, cheaper and accessible to more people. 

Conclusion

There are other potential use cases of DeFi, but the most widely used ones are the one mentioned above. Decentralized finance is focused on building financial services separate from the traditional centralized systems. As a result, there will be a more open financial system in the future that could potentially prevent censorship and financial discrimination all over the world.