Lesson 14 – What is DeFi?

DeFi, short for “Decentralized Finance”, is a term that’s becoming increasingly popular in the world of investing. At its core, DeFi refers to a new type of financial system that operates entirely on the blockchain, particularly on the Ethereum blockchain. In contrast to traditional finance, where intermediaries such as banks and financial institutions act as gatekeepers and decision-makers, DeFi operates in a decentralized manner, allowing for peer-to-peer (P2P) transactions without intermediaries.

How does it work and what is DeFi used for?

DeFi is accessed via dApps (decentralized applications) that operate on a corresponding blockchain, such as the Ethereum or Solana blockchain. These dApps do not require any account opening process or applications like traditional banks. They integrate a smart contract and a user interface that allows users to interact with the application. Smart contracts, at the heart of DeFi, are self-executing agreements that operate on a blockchain network. The contracts are designed to be transparent, immutable, and secure, meaning they cannot be altered once deployed. Smart contracts enable DeFi applications to function autonomously, without human intervention, while still being completely transparent and auditable.

DeFi applications can also offer a variety of financial services, such as lending and borrowing, trading, and asset management, some of which are elaborated below:

1. Lending and borrowing: With DeFi lending and borrowing, people can lend or borrow cryptocurrency without needing permission from banks. Users can earn interest on their crypto holdings or take out loans using their crypto assets as collateral.

2. Yield farming: With yield farming, users can earn rewards and fees by locking up cryptocurrency in a DeFi protocol.

3. Insurance: Users can purchase decentralized insurance to mitigate risks like smart contract failure or security vulnerabilities.

4. Prediction markets: These platforms allow users to wager on the outcome of events such as elections or sporting events. Users can earn rewards for accurate predictions.

Why is DeFi important and what are its advantages?

DeFi is an innovative and disruptive technology with the potential to reshape financial landscapes and revolutionize the way we think about investing and financial transactions.
Here are some of its benefits:

Security

DeFi applications operate on a decentralized blockchain network, meaning it is not possible to alter already-recorded transactions. This reduces the risk of transaction alterations, making the system less vulnerable to hacking or exploitation.

Of course, as with any new technology, there are also risks associated with DeFi. Its decentralized nature means there’s no one to turn to if something goes wrong. The complexity of DeFi can also be challenging to understand and pose potential difficulties. Additionally, as with the cryptocurrency market, DeFi is expected to exhibit significant volatility.