What is Decentralized Finance (DeFi)? – Easily Explained

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In 2009 the world was introduced to Bitcoin. Bitcoin, unlike other currencies at the time, allowed us to really own and control value. We could send it around the world, use it for payments and transact peer-to-peer without a need for centralized intermediaries. Over time, Bitcoin’s best use case has been a secure store of value. But what was so great about Bitcoin was that it was open to anyone. Other than the need for an internet connection, there weren’t any barriers to entry. On top of this, Bitcoin’s rules of scarcity and transparency (that have been directly integrated into the technology) meant that it wasn’t like traditional financial instruments. It was something different. It was the first DeFi application.

DeFi (decentralized finance) is a global, open alternative to the current financial system. Whereas the current financial system is opaque, tightly controlled, and outdated, DeFi empowers individuals by giving them personal control and visibility over their finances. For individuals who are victims of poor governmental economic activity, DeFi gives exposure to global markets and alternatives to local currencies & banking options. For anyone with an internet connection, DeFi opens up doors to new, innovative financial services that are largely controlled by the users themselves.

DeFi applications let individuals borrow, save, invest and trade without the need of third parties like banks, exchanges, or lending companies. DeFi is able to remove third-party interference because applications are built on open-source technology that anyone can maintain and contribute to. With DeFi, markets are open 24/7 and there are no centralized authorities that can block or deny access or payments. Services that were previously slow and at risk of human error are now automatic and safer because they’re handled by code that is executed automatically and can be inspected and scrutinized by anyone.

To truly understand the benefits of DeFi, we must first understand the problems with the traditional financial system that exists today.

  • Some people aren’t granted access to set up a bank account or use financial services.
  • Lack of access to financial services can prevent people from being employable.
  • Financial services can block you from getting paid.
  • A hidden charge of financial services is your personal data.
  • Governments and centralized institutions can close down markets at will.
  • Trading hours are often limited to business hours of specific time zones.
  • Money transfers can take days due to internal human processes.
  • There’s a premium to financial services because intermediary institutions need their cut.

Whereas traditional financial intermediary institutions hold your money, DeFi applications allow individuals to be the custodian of their own money. And with this, users can control where their money goes and how it’s spent, instead of having to trust companies like banks to not mismanage their money by lending it to risky borrowers for example. On top of this, because DeFi applications are autonomous, the transfer of funds happens in minutes instead of potentially days like it is with traditional finance. Transaction activity is also pseudonymous instead of tightly coupled with your identity.

One of the most impressive things about Bitcoin was that it was permissionless; open to anyone. The same is true with DeFi. Instead of having to apply to use financial services, individuals can openly use DeFi applications without the need to go through a lengthy and rigorous application and KYC processes. One of the biggest differences between DeFi and traditional finance is that DeFi is built on the principle of transparency. Anyone can look at an application’s data and inspect how the system works. However, the processes in the traditional financial system are normally closed and hidden.

Some people like the idea of DeFi, but they cannot fathom the full potential of what you can actually do with it. In fact, there is probably a decentralized alternative to most financial services. You can send money around the globe easily. You can access stable currencies from anywhere in the world. You can borrow money from decentralized providers. You can use DeFi to start saving, investing or start trading. You can use DeFi applications to crowdfund projects or ideas. You can even use DeFi applications to buy faster, cheaper, and more transparent insurance.

DeFi applications work by taking advantage of cryptocurrencies and smart contract technology. This enables applications to provide services that remove the need for intermediaries. Smart contracts are essentially agreements that are written in code instead of traditional languages. No one can alter that smart contract when it’s life – it will always run as programmed. In DeFi, smart contacts replace the financial institution in a transaction.

For example, a smart contract that’s designed to hand out an allowance or pocket money could be programmed to send money from Account A to Account B every Friday. And it will only ever do that as long as Account A has the required funds. No one can change the contract and add Account C as a recipient to steal funds. Contracts are also public for anyone to inspect and audit. This means bad contracts will often come under community scrutiny pretty quickly.

Final Thoughts

DeFi is a global alternative to the current financial system. DeFi applications let you borrow, save, invest, trade, and do much more with your money than traditional financial systems will allow. DeFi is based on open-source technology that anyone can program, making it more secure, transparent, and fair for the users. We’re now starting to see much greater DeFi mass adoption. So far, tens of billions of dollars have flowed through DeFi applications. You can expect there to be much more flowing through DeFi in the future because momentum is growing every single day.

Hi, I'm Jack. I'm a creative and technical writer in the cryptocurrency industry. I chose a career in blockchain because I believe that it is the technology that will have the biggest impact on and revolutionise the world as we know it. Being involved in that excites me. Although its easy to get caught up in the hype surrounding cryptocurrencies, I'm more excited to see blockchain realise its full potential and completely disrupt the legacy systems of the 21st Century. I've been in this industry for multiple years and I've worked for some of the biggest research and development companies as well as smaller, startup crypto projects.