What is DeFi?
Decentralised Finance (DeFi) is an emerging financial technology which aims to democratise financial services by eliminating middle men. DeFi aims to achieve this by leveraging on decentralised distributed ledger management system aka blockchain technology. In simpler words, DeFi provides financial services without third parties such as intermediaries, brokerages and banks by using smart contracts in blockchain. This creates a near peer to peer transaction ecosystem giving more power to end users.
How does DeFi work?
DeFi as a service is made available to user in a dApp (decentralised application) interface which is built on blockchain ecosystems such as Ethereum or Solana. DeFi essentially covers the full broader spectrum of financial services be it retail or professional.
Various services ranging from simple services such as deposits, insurance, lending and borrowing to complex services such as contractual agreements, professional asset management, trading and other investments are powered by protocols which are built on these blockchain networks.
In DeFi, all transactions are carried out using cryptocurrencies as assets. The service providers rely on smart contracts to facilitate peer to peer exchange which eliminates middle men such as banks, guarantors and other various intermediaries. To start using DeFi all you need is a crypto wallet and some assets in form of cryptocurrencies.
What are the advantages of DeFi?
It provides tamper proof transaction records as data of each transaction is spread across the blockchain ledger preventing falsification.
Users gain certain level of anonymity as they most often don’t need to fill in any forms or share personal data aside from wallet information.
Given that transactions often take place peer to peer, there is better flexibility as you don’t have to wait on anyone else to gain permission before making transactions.
As middle men are eliminated, the part of funds which usually go in the form of fees is now allocated back to user gaining better returns on their transactions.
Some clearly visible advantages of DeFi are in real world application are better interest rates when funds are deposited, make purchase directly from exchanges instead of brokerages when trading etc.,
Is there any disadvantage or limitation in DeFi?
The liquidity for your investment may face high volatility depending on blockchain in which the DeFi is built.
Another inherent weakness is the limitation coming from wallet. A user needs to keep his private key and seed phrase safe as loss of the key could lead to losing access to all assets stored inside the wallet.
Given limited number of participants owing to early stages of DeFi propagation and lack of regulatory body there is higher probability for lack of consumer protection measures.
Most popular real world DeFi services.
While DeFi covers the complete broader spectrum of financial services in theory, there are still limitations in real world application of various financial services. In today’s DeFi market, the most commonly found application of financial services are
Common practices — individual payments, fund transfers, lending and borrowing
DEX — Decentralised Exchange — a DeFi dApp designed to facilitate trading via peer to peer financial transactions.
Yield Harvesting — A sort of asset management in which user allocates idle tokens or portion of token which owner feels comfortable making speculative bets on by lending them out to gain interest and fees for tokens being used elsewhere.
