A Guide to Decentralized Finance (DeFi)
What is Decentralized Finance (DeFi)?
Decentralized Finance (or simply, DeFi) is a movement that aims to decentralize financial applications. DeFi is built on public, open-source blockchains that are free to access by anyone with an Internet connection (permissionless). This is a crucial element for onboarding potentially billions of people to this new, global financial system.
In the growing DeFi ecosystem, users interact with smart contracts and each other through peer-to-peer (P2P) networks and Decentralized Applications (DApps). The great advantage of DeFi is that while it makes all this possible, users still maintain ownership of their funds at all times.
Simply put, the Decentralized Finance (DeFi) movement aims to create a new financial system that’s free from the limitations of the current one. As it happens, due to its relatively high degree of decentralization and large developer base, most of DeFi is currently being built on Ethereum.
What can Decentralized Finance (DeFi) be used for?
You probably already know, but one of the great advantages of Bitcoin is that no central party is needed to coordinate the operation of the network. But what if we use this as our core idea and make programmable applications on top of it? This is the potential of DeFi applications. No central coordinators or intermediaries, and no single points of failure.
As mentioned above, one of the great advantages of DeFi is open access. There are billions of people around the world who don’t have good access to any type of financial service. Can you imagine how you’d manage your day-to-day without any certainty of your finances? There are billions of people who live like this, and ultimately, this is the demographic that DeFi is trying to serve.
Will Decentralized Finance (DeFi) ever reach the mainstream?
This all sounds great, so why hasn’t DeFi taken over the world yet? Well, currently, most DeFi applications are hard to use, clunky, break frequently, and highly experimental. As it turns out, engineering even the frameworks for this ecosystem is extremely difficult, especially in a distributed development environment.
Solving all the challenges of building the DeFi ecosystem is a long road ahead for software engineers, game theorists, mechanism designers, and many more. As such, whether DeFi applications ever make it to mainstream adoption remains to be seen.
What Decentralized Finance (DeFi) applications are there?
One of the most popular use cases for Decentralized Finance (DeFi) is stablecoins. Essentially, these are tokens on a blockchain with their value pegged to a real-world asset, such as a fiat currency. For example, BUSD is pegged to the value of the USD. What makes these tokens convenient to use is that since they exist on a blockchain, they are very easy to store and transfer.
Another popular type of application is lending. There are many peer-to-peer (P2P) services that allow you to lend your funds to others and collect interest payments in return.
Arguably the most exciting part of DeFi, however, are the applications that are difficult to categorize. These can include all kinds of peer-to-peer, decentralized marketplaces, where users can exchange unique crypto-collectibles and other digital items. They can also enable the creation of synthetic assets, where anyone can create a market for pretty much anything that has value. Other uses can include prediction markets, derivatives, and many more.
Decentralized Exchanges (DEXs) on Ethereum
A Decentralized Exchange (DEX) is a venue that allows trades to occur directly between user wallets. When you trade on a centralized exchange, you send your funds to the platform, and trade through its internal systems.
Decentralized Exchanges are different. Through the magic of smart contracts, they allow you to trade directly from your crypto wallet, eliminating the possibility of exchange hacks and other risks.