Decentralized Finance (DeFi) consists of finance-based applications and products that are built on the top of blockchains. These decentralized applications (Dapps) possess the basic characteristics of the underlying blockchain network. Developers can create such applications based on open-source networks. DeFi is one of the fastest-growing sectors in the blockchain industry. Ethereum is the major blockchain that is currently being used to develop DeFi applications.
What are DeFi applications?
Decentralized Finance (DeFi) applications enable users to perform financial activities without the intervention of any centralized regulatory authority. These applications offer a transparent and trustless framework system that uses permissionless blockchains. This minimizes the operational cost and time.
Defi versus Traditional Finance
“Whereas Wall Street [provides] financial services where the ultimate ‘settlement layer’ is courts and legal proceedings, DeFi [provides] financial services where the ultimate settlement layer is code.”
– Brendan Forster, co-founder, and COO at Dharma (quoted to Quartz)
- Programmable: By using smart contracts, developers can program business logic into decentralized financial services applications.
- Permissionless: Being open-source, developers can freely build things on top of decentralized systems without asking for permission.
- Decentralized: Records are stored and updated simultaneously across thousands of computers instead of a central server.
- Trustless: Community members, especially developers and token holders, are allowed to participate in governing the financial system, reducing the concentration of power and control.
- Transparent: Once a transaction is validated by the code, included in a block, and confirmed by subsequently blocks, it becomes permanent, verifiable, and secure on the blockchain.
- Interoperable: Decentralized finance can be made interoperable across different services.
- Borderless: Money and value can flow seamlessly across different services and borders, potentially creating an internet of value, promising true global citizenship.
Did you know?
- You can take loans without going to a physical bank.
- You can insure your smart contracts through decentralized insurance.
- There is a blockchain-based lottery system.
The infographic below displays the important use cases of DeFi.
Practical Use Cases
These DeFi based applications, protocols, or solutions are creating payment ecosystems for underbanked and unbanked populations.
Asset Management Tools:
Asset Management DeFi solutions hold all crypto-related details like wallets, applications, dashboards, and other information in a single interface. These solutions also provide automated asset management strategies to a user.
Lending and Borrowing:
With DeFi, both the lenders and borrowers can connect directly. Users use these autonomous protocols to earn interest on deposits and also borrow assets.
Margin trading can be considered as an extension of borrowing. Users trade assets and make a profit using funds borrowed from a third party.
Such solutions enable permissionless and private transfer of value between any blockchain.
This currently includes insurance for the DeFi ecosystem. Example: Smart Contracts, crypto wallet, collateral, etc.
Decentralized Exchange Protocols (DEX):
DEXs are P2P exchanges of assets, where no third-party acts as the intermediary in a transaction.
Non-fungible tokens (NFTs) marketplaces are slowly coming into the picture. These platforms facilitate the exploration, discovery, and buying/selling of crypto assets.
A stablecoin is the bridge to the traditional financial system. It is an asset that offers price stability characteristics making it suitable as a medium of exchange, a unit of account, and a store of value.
There is no central authority regulating and controlling the entire prediction market (taking of bets, the selection of the events to bet on, and also the payouts). Thousands of users’ activities and reporting validate outcomes. They maintain the integrity of the market.
In decentralized identity solutions, there is no central party to retain a user’s identity details. Nor can the users details be used without the prior permission of the user.
Limitations of Decentralized Finance
- Trust: The technology is not user-friendly and prone to vulnerabilities. With so many hacks currently happening into the crypto space, Decentralized Finance applications need to be bulletproof. Security protocols will help.
- Education: We are still in a phase where a majority of the population does not even know Blockchain is, let alone Decentralized Apps. Education is the key.
Read our step-by guide on how to use the McAffee DEX.
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