19th Feb 2021

Decentralized Finance – What it is and why it is important?

Blockchain

Written By, Meet Siraja

What is DeFi?

If you are connected to the blockchain and crypto space, you may have heard of DeFi. DeFi is short for Decentralized Finance. DeFi is a new form of finance which does not rely on centralized finance intermediaries like banks, exchange, etc. It means that it offers kinds of financial services that exist in the traditional financial system, but in a decentralized way.

DeFi transforms old financial products into a trustless and transparent protocol, that can run without any intermediaries and give you provable ownership of your assets.

Main advantages of DeFi

DeFi is characterized by the fact that it extends the use of blockchain from simple value transfers to more complex financial use cases.

You can refer to the below diagram to understand the difference between our Centralized banking system and Decentralized Finance.

defi-system

DeFi applications eliminate the need for any intermediaries. Smart contract of the Defi applications is designed to have a resolution for all the possible disputes and users will have control over their funds at all times. Because these smart contracts are deployed on top of the blockchain, thus single points of failure are eliminated.

The smart contract code of DeFi applications is open source. Thus anyone can audit it. This creates a different kind of trust among consumers as it gives everyone the opportunity to understand the smart contract functionality or find bugs.

Main DeFi Use Cases

Lending & Borrowing:

Lending and borrowing are one of the most important elements of any financial system. The whole concept is quite simple. Lenders deposit their funds to earn interest and Borrowers are willing to pay interest on the amount they borrowed.

In the traditional system, Lending & Borrowing is facilitated by an institution such as a bank.

In the cryptocurrency space, Lending & Borrowing is facilitated by DeFi Protocols such as Aave and Compound.

Automated Market Maker:

Automated Market Maker is also known as AMM. AMM replaces the traditional limit order book where assets are traded automatically against the pool’s latest price. Automated Market Makers are smart contracts that create liquidity pools for the token which are automatically exchanged by an algorithm rather than a traditional order book.

There are several Decentralized Exchange, which are using AMM concepts. Kyber Network was the first one to introduce the Automated Market Maker concept in the blockchain space in early 2018.

Uniswap, Balancer, and Curve are the other exchanges that use the Automated Market Maker concept for trading.

DeFi is never going to end anytime soon

defi-value

At the time of writing, a total of $40.09 Billion of funds is locked in all of the DeFi Ecosystem, which is a very huge number and this is increasing day by day. Ethereum has become the blockchain of the choice for many companies to build their financial product on it.

We hope you have learned something from this article. We will continuously come up with more advanced DeFi concepts.

Written By,

Blockchain Developer at Yudiz Solutions Pvt. Ltd