A typical financial system comprises government, banks, and public financial companies. While the Government is responsible for generating fiat money such as dollars and rupees the banks and other public companies have been responsible for being the intermediator to the public in using the fiat money. There is no technology as such till now that can keep track of fiat money through a common infrastructure. The intermediates like banks act as an authority in keeping track of your fiat money in the form of digital assets. The idea of decentralized finance (Defi)and exchange (DEX) is to keep track of almost all forms of transactions produced traditionally, digitally, and virtually on a global scale. Technology such as Blockchain enables a global digital footprint in a financial ecosystem.
Decentralized finance and exchange exploit the blockchain chain model to provide a global digital footprint for its users eliminating intermediaries to act on tracking the flow of their digital currencies and making it more of a peer-to-peer network. The blockchain plays an important role in maintaining transparency by having a public ledger that holds all the records over a global shared network more like the internet. The concept of a Defi is to have a financial ecosystem living digitally on a shared infrastructure where typical financial services such as borrowing, lending, and trading exist on a public network and are accessible to anyone on the internet. Due to its similar nature Blockchain technology allows such decentralized finance or Defi ecosystem to exist by opensource protocols and modular frameworks.
Decentralized finance and exchange are a very big and ever-expanding platform on the blockchain. Defi’s decentralized architect originates from DApps (Decentralized applications) which are programmed to execute finance — functionalities on the blockchain. Dapp solutions enable users to transact directly through mechanisms mediated by smart contracts developed on blockchain. The decentralized nature of these smart contract-based approaches is that they can be programmed to work in conjunction through building blocks of DApps, therefore it is possible to develop mechanisms that can execute financial service requirements of even greater complexity.
For example, Dapps with smart contract programming to adjust interest rates can do so in an automatized and dynamic manner, allowing a larger pool of users to transact at dynamically calibrated rates according to such asset. The first entity that may be considered a Defi platform was MakerDAO (the term DAO signifying “Decentralized Autonomous Organization”), which also produced and today maintains the stable coin DAI. MakerDAO enables people to assume a credit liability on DAI cryptocurrency while attempting to maintain a peg with the US Dollar. Although this mechanism of DAI dissemination on a credit basis represented a novel form of transacting with cryptocurrencies, there has been a flourishing of other new models for Defi since 2020.
Another Defi example is Uniswap , a decentralized exchange premised on forming large liquidity pools to swap tokens. Built on the Ethereum blockchain, Uniswap serves as an exchange for hundreds of Ethereum-based digital tokens, and its algorithm creates dynamic incentive structures for users to form liquidity pools by compensating them for trading fees. Uniswap thus offers an alternative structure for order-filling as performed by centralized market makers.
