Decentralized finance (DeFi) is often cited as an innovation that will drastically change the financial sector in the future. DeFi refers to financial products and services that can be accessed by anyone using Ethereum.
According to the ethereum.org page, DeFi has the characteristics of an open market, and is not beholden to a centralized authority that can block payments from someone or prevent someone from accessing them.
Simply put, decentralized finance is an ecosystem of blockchain-based financial applications that can operate without a centralized authority such as a bank or other financial institution.
Currently, almost every financial product or service, such as savings, loans, insurance, and stock markets are still managed by centralized systems. However, via blockchain, financial transfers can be made through the intermediary of crypto assets. The technology is also capable of facilitating decentralized financial services, and is not just limited to sending and receiving crypto assets.
How DeFi works
The DeFI application stems from the invention of the Ethereum blockchain with smart contract technology, according to the Pintu website. In simple terms, smart contracts are a programming language that allows the automatic setting of contracts between two parties in a blockchain system.
Smart contracts function to execute pre-programmed commands automatically when a certain condition in the program is met, both for token transfers between Ethereum addresses and other types of transactions.
With smart contract technology, the Ethereum blockchain allows for a more complex level of programming, giving developers the freedom to experiment with their own code, and create so-called decentralized applications (DApps). DeFi are essentially DApps that focus on making traditional financial services decentralized.
If previously financial services depended on institutions such as banks acting as intermediaries, then through DeFi the transaction process is carried out by code written on smart contracts.
DeFi application code is generally transparent and open with all users able to verify their own application code. Thus, users can have full control over their funds.
So, in the DeFi space, smart contracts replace financial institutions in transactions. Smart contracts can hold funds and send/return them based on certain conditions. No one can change a smart contract once it has been executed, and it will always operate as programmed.
Benefits of DeFi
With this way of working, DeFi is allegedly useful for providing access to financial services for anyone who cannot enjoy traditional financial services such as banks.
At the same time, DeFi also supports financial inclusion. The application opens access for all levels of society to utilize financial services. Moreover, financial inclusion is expected to help people get out of poverty, reduce social inequality, and encourage economic growth.
Transaction activities in the DeFi application also tend not to be costly. The reason is, as mentioned earlier, the decentralized financial system is not regulated by centralized authorities or intermediary institutions such as banks.
That allows transactions in the DeFi system to take place without long layers of bureaucracy. In turn, the cost of financial services activities in DeFI can be reduced.
Types of DeFi applications
DeFi technology has been used in a number of financial applications. The following is a list of types of DeFi applications quoted from various sources.
According to Pintu, decentralized exchanges (DEXs) are applications that facilitate the exchange of one token for another using smart contract technology. One of the most popular examples of DEXs built on Ethereum today are Uniswap and Sushiswap
DEXs make it possible to exchange ETH for ERC-20 tokens or vice versa, as well as exchange between ERC-20 tokens. Any token can be exchanged as long as it follows the ERC-20 token standard.
However, DEXs also exist on non-Ethereum blockchains, such as PancakeSwap. The app is built on the Binance Smart Chain blockchain with BNB (Binance Coin) as its currency. Just like the Uniswap protocol, PancakeSwap allows its users to exchange crypto assets.
Crypto asset lending
Lending and borrowing protocols are one of the most popular types of DeFi applications. The lending platform in DeFi has many advantages over conventional lending systems, such as instant transaction settlement. Another advantage is the ability to pledge digital assets, and apply for credit without long bureaucracy.
In addition, lending and borrowing activities in the blockchain system are also not exposed to risks from third parties. That way, the process becomes cheaper, faster, and can be used by everyone.
One of the popular lending-based DeFi applications is AAVE and Compound. On these Ethereum-based platforms, users can deposit crypto assets to earn interest, and also borrow other crypto assets.