DEFI: The path to decentralized finance under blockchain technology

Finance plays an important role in the global economy today, but it is not an open system. After all, even if there’s a bank under your window, you might not be able to get a loan for a new business and run out of financing. DEFI wants to change that. With this initiative, all you need to interact with the system is a basic tool of our time: a smartphone. And anyone can be part of it.

DEFI stands for decentralized finance and is a general term for classic financial services that are processed by a decentralized platform such as blockchain. While theorists argue about the possibilities of blockchain technology, builders are busy creating it. In recent years, we have witnessed a growing wave of ambitious projects that have joined forces to fight against the centralized financial system and transform the traditional banking economy. The alliance of these projects is now officially called DEFI.

DEFI wants to be completely independent of the traditional banking system. But what is DEFI in general? It is a combined movement of projects that promotes and expands, a decentralized architecture using blockchain technology on which you can create traditional financial instruments. This will keep these instruments out of government and regulatory control. In other words, the idea is to develop and operate decentralized financial tools based on blockchain, such as digital assets, p2p protocols and dApps.

What is DEFI?

DEFI are financial instruments in the form of services and applications that are built on blockchain platforms. The main goal of decentralized finance is to become an alternative to the banking sector and replace traditional technologies of the current financial system with open-source protocols. That is, open access to decentralized loans and new investment platforms for many people. And thus, allow them to earn passive income from cryptocurrency assets, as well as save on transfer fees, loans, and deposits.

Their goal is to empower the voice of the “common people” while creating an open, efficient, and comprehensive financial system accessible to all. Using smart contracts, DEFI platforms provide financing without regulatory restrictions. This enables access to financial services for all, even those who do not have a traditional bank account. DEFI is growing rapidly and already has many important real-world use cases. These include decentralized exchanges, lending platforms, forecasting markets among others.

Decentralized finance is geographically unlimited access to financial services. DEFI uses the benefits of cryptocurrencies, blockchain technology and smart contracts to provide financial services such as: loans, deposits, credits, decentralized exchanges (DEX), among others. DEFI is playing an important role in the evolution of the financial sector. One reason is that it extends the functionality and reach of money, because all that is needed to participate in the DEFI sector is a smartphone.

How did this concept originate?

DEFI is one of the fastest growing cryptocurrency segments. Cryptocurrencies are distinguished by different segments, such as blockchains themselves, stable coins, digital collectibles (NFTs, non-fungible tokens), prediction markets, decentralized autonomous organizations (DAOs) and more. The DEFI movement is the segment that began in late 2018, when a network of 15 Ethereum-based projects came together to build an independent, open financial system.

The idea is simple. If all traditional financial institutions are nothing more than a software that is controlled by some legal entities, why not make all these institutions be on Ethereum or other blockchain autonomous smart contracts? Thus, protocols emerged that allow, without an intermediary, to trade cryptocurrencies on decentralized exchanges (Uniswap), lend (Compound), manage monetary policy and issue Stablecoins (MakerDAO), do asset rebalancing (TokenSets), risk insurance (Nexus Mutual) and, in general, do everything that traditional financial institutions do.

What technologies are used for DEFI?

DEFI is inspired by blockchain, the technology behind the digital currency bitcoin that allows multiple organizations to keep a copy of their transaction history, giving it its decentralized nature. This is important because centralized systems and human gatekeepers can limit the speed and complexity of transactions, giving users less direct control over their money. DEFI is different because it expands the use of blockchain from simple transfers of value to more complex financial use cases.

Most existing DEFIs are based on the Ethereum blockchain. Since, the Ethereum smart contract platform, which automatically executes transactions when certain conditions are met, offers much more flexibility. Ethereum programming languages such as Solidity are specifically designed to create and implement such smart contracts. However, DEFIs rely heavily on Dapps which are programs designed to run on decentralized networks. Dapps require very little human intervention and integrate advanced smart contracts to enhance trading systems.

How is it different from centralized finance?

DEFIs differ from centralized finance in several ways, one of which is the way money is issued: in centralized finance it is issued by the government or central banks. While in DEFIs money is issued, in the form of a reward for PoW and PoS mining. In other words, miners find solutions to create a new block in the network and receive a reward for it in the form of new coins.

In centralized finance the lenders are banks and investments are made through shares bonds or other instruments that are traded on the stock exchange in legal tender through a bureaucratic process. While in DEFIs cryptocurrencies and tokens are traded, loans are granted through decentralized platforms between traders without bureaucratic processes and you can invest in ICOS and basket of tokens.

How does it work?

The user sends an existing crypto asset (e.g. ETH or USDT) to the smart contract address of the DEFI platform. In return, he receives the platform’s internal tokens (e.g., in Compound – ETH and USDT). These tokens can be used to trade or generate passive income. The user can always get the original asset back by performing transactions in reverse order. If you received income, when you sell the tokens on the platform you will receive the original asset in your wallet for a higher amount.

Tokens move between DEFI platforms through normal blockchain transactions. The user can withdraw tokens from one platform and invest them in another, retaining full control of their finances, something that is not available from banks or exchanges. This independence has a disadvantage: only the owner of the tokens is responsible for their security. If he loses the keys to the wallet or if they are stolen by hackers, the assets will be irretrievably lost.

What are the advantages of using tokens?

One of the main advantages of using DEFI services is their low failure rate. This is because it is based on the blockchain system which is highly secure. Another advantage is that DEFIs significantly limit the involvement of intermediaries, reducing the number of intermediaries, and consequently reduces the costs associated with the provision and use of financial products. Additionally, anyone with a smartphone with Internet access can use the solutions offered by DEFIs.

Traditional banking often makes it difficult for low-income people. Decentralized financial applications are a cheaper solution, so they can be successfully offered to low-income people. Like all blockchain, decentralized finance offers transparency. The user can easily track transactions and changes. The applications are “open source,” meaning that their source code is available to everyone. In addition, thanks to DEFI apps you have full control over your finances.

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