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In this article, we will discuss what is DeFI in detail. Let’s start.
What is DeFI?
DeFI is a short form of the term decentralized finance. As the name indicates it aims for a peer-to-peer financial system without the need for centralized financial institutions or a third party.
How Does a DeFI Work?
The technology behind this decentralized financial system is a public blockchain network including, smart contracts and cryptocurrencies.
Decentralized finance was previously known as open finance. It removes the intermediary party or centralized institutions between the user and the business and forms an open peer-to-peer connection for decentralized exchanges. There is no bank or financial institution overlooking the user’s financial transactions and bank account as in centralized finance.
The DeFI network is considered a transparent financial network. The blockchain code is open-source which means that users can access and review it with full transparency. Traditional financial institutions do not offer such transparency.
Moreover, there are no geographical boundaries or legal obligations such as paperwork to complete before joining a DeFI system to use digital currencies and fulfill financial transactions. On the other hand, for the traditional finance system, there are conditions to fulfill before a person becomes eligible for taking bank loans, etc.
Anyone with an internet connection can access a DeFI network through DApps (decentralized apps). Mostly, DApps are built on ethereum blockchain technology. Smart contracts are used to set financial agreements between the immediate users without the need for a third party.
Smart contracts are stored on public blockchain networks and are accessible to everyone. Moreover, these smart contracts cannot be altered which makes the network more secure for users.
There are some concepts like liquidity mining where DeFI applications attract users by giving them free tokens and yield farming where experienced users can go through various DeFI tokens for higher returns before making an investment.
Now, let’s discuss the components of a decentralized financial system.
Composition of a DeFI Network
A Decentralized finance network consists of five layers which are as follows:
1. Settlement Layer
This layer forms the foundation of the network. For example, Ethereum forms the blockchain network and ether is the network’s currency. This principal layer sets the network rules and also ensures its security.
2. Asset Layer
This layer consists of all the tokens and digital assets that can be used on the network natively.
3. Protocol Layer
This layer sets the rules and guidelines for the smart contracts that are used in digital transactions.
4. Application Layer
This layer forms the user interface for the users to interact with the blockchain-based DeFI apps.
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5. Aggregation Layer
The final layer connects various financial products like DApps and defi protocols to fulfill DeFI use cases.
Next, let’s have a look at some of the uses of decentralized finance technology.
Use Cases of Decentralized Finance
Decentralized finance can be used in multiple ways, like,
- For lending and borrowing money in the form of cryptocurrency. Users can gain interest by lending crypto assets every minute.
- For taking a loan instantly (flash loans) without any paperwork and other conditions to fulfill.
- For trading digital assets like stocks without any middle-man or broker in between.
- For placing bets on assets or buying derivatives. These can be short or long-term.
- For investing in future savings by placing cryptos in saving accounts and gaining better interest rates, etc.
According to the reports in 2021, the market size of the current defi ecosystem will be 100 times larger in the next five years. It is an emerging technology. The potential of DApps makes the concept of decentralized finance even more promising.
Read our guide on how you can develop a DApp for more details.
If you are looking for experienced developers to help you create market-competitive blockchain networks and apps, DevTeam.Space can help you.
Read in detail the competencies of our blockchain developers here.
You can easily get in touch with our technical manager via this quick form. Explain to us your initial DeFI application development requirements and one of our technical managers will get back to you to assist you further.
Top FAQs on What is DeFI
It is a decentralized finance network based on blockchain, a secure and immutable distributed ledger technology, accessed through decentralized applications.
Decentralized finance (DeFI) users can use deFI apps for a decentralized exchange or financial activity, like sending money instantly for peer-to-peer payments, storing money in digital wallets, lending and borrowing money, trading cryptocurrencies and other financial assets like NFTs, etc.
DeFI applications are based on complex software code. There is a learning curve and risk associated with fluctuating nature of transaction rates on a blockchain network like ethereum and overall complex financial transactions.