DeFi, or decentralized finance, is the set of financial tools and services based on blockchain and smart contracts. Can apply it to utilities as different as peer-to-peer lending, cryptocurrency exchange, predictive markets, etc.
DeFi is what the set of decentralized financial tools and services that are based on blockchain and decentralized finance is called. They are used to create financial instruments without intermediaries, such as decentralized lending and cryptocurrency exchange platforms.
What is DeFi?
DeFi is the term used to refer to financial services based on blockchain. It could be translated as Decentralized Finance and is considered a growing sector that integrates with traditional financial services.
How does DeFi work?
To understand how DeFi works, it is necessary to understand the figure of smart contracts and decentralized applications.
A smart contract is made in the blockchain based on predetermined programming, self-executing. That enables the possibility of specific operations and transactions that respond, in a decentralized manner, to certain requests.
For example, we can program a smart contract to activate a cryptocurrency upon a given stimulus, price variation, date, etc.
What the smart contract avoids is intermediation. Another example is if a DeFi loan is requested, the Smart Contract will execute the order upon activation by recording the data permanently (and privately) in the blockchain.
That contributes to the transparency of operations since they will not depend on intermediaries: blockchains are built under the governance of multiple users who guarantee this transparency and anonymity.
How DeFi differs from traditional finance
There are many differences between decentralized and conventional finance. The main one would be simplifying the access processes for the end customer: in traditional finance, it will generally be necessary to provide other complementary products such as accounts, etc.
How can DeFi be applied?
There is a large (growing) number of DeFi applications and services. That is a growing sector within the Fintech label. Such as:
- Decentralized lending: through platforms that connect lenders with people seeking finance. This connection is made through smart contracts without the use of intermediaries.
- Decentralized exchange platforms (DEX): these are one of the best examples of decentralization. They are dedicated to the exchange of cryptocurrencies in which there are no intermediaries since smart contracts are the ones that facilitate the P2P function.
- Predictive platforms are decentralized predictive markets in which different types of speculations and information trading occur. In this case, again, without the use of intermediaries.
Advantages and disadvantages of DeFi
The main advantages of DeFi are:
- They eliminate intermediaries facilitating faster and more secure transactions.
- They offer greater transparency as collective governance is much more efficient than centralization.
- Saves costs by eliminating the figure of intermediation and many verification processes that are carried out automatically.
Disadvantages of DeFi:
The danger of technical errors: errors in the coding of a smart contract can lead to serious performance problems 2.
- Exposure to fraud: as it is a new and still little-known model, it has high exposure to possible scams.
- Governance problems: collective governance, although considered a benefit, if misused, can also generate control issues attempts or similar.
In decentralized finance, processes are simplified. They are carried out over the Internet and, in many cases, can even be executed without being banked (banks do not intervene).
The other important difference is that, as they are based on open codes, decentralized finance has a much greater capacity for interoperability and connection than conventional finance, which is generally limited to the products and services of the entity offering them.