What is DeFi? The latest hype in cryptocurrency
One of the most popular applications of blockchain technology, DeFi (Decentralized Finance), has recently gained a lot of prominence in the crypto space. The basic idea behind the introduction of DeFi was to merge the benefits and attributes of blockchain with the financial sector and innovate everyday processes and financial activities.
Although the technology is already used in modern finance nowadays, the incorporation of blockchain technology into finance became a necessity to conduct transactions without the intervention or supervision of a third party such as banks.
Our current financial system is centralized. Authorities and regulators acting as validators limit the speed of transactions when a payment is to be processed between two parties. In simple words, the bank acts as a guarantor for the transaction between buyers and sellers and often charges transaction fees to make the transaction process smooth and secure.
For example, when someone pays for their coffee with a credit card or buys an item online, the bank always plays the role of a middleman and manages the transfer of funds. To eliminate the need for a middleman while maintaining security and trust in peer-to-peer transactions, DeFi was developed.
DeFi includes several blockchain-based applications built on Ethereum, the second largest cryptocurrency platform in the world. Since its launch in 2015, Ethereum has provided a platform for building and developing decentralized applications and smart contracts to address complex use cases in finance.
With the advent of smart contracts, people have been able to automate multiple transaction protocols, eliminating the need for third-party oversight. DeFi, powered by smart contracts, provides users with flexibility, control, and security by automatically processing payments and transactions by verifying certain conditions that were previously defined when the contract was set up.
For example, a user can add a rule to their smart contract that says they will only send money to their friend next Wednesday if the temperature is less than 20 degrees Celsius. If these conditions are met, the transaction will be carried out automatically, without the need to involve a central office such as a bank.
Meanwhile, the DeFi ecosystem has evolved drastically, and various crypto applications have become very popular. For example, decentralized exchanges (DEXs) are very popular in the crypto space.
Unlike traditional exchanges, DEXs allow direct peer-to-peer trading and transactions in the absence of an intermediary. In addition to DEXs, stablecoins have also emerged as a significant and popular application of DeFi. Stablecoins are cryptocurrencies that are pegged to another asset such as the dollar, euro, or gold.
The price of a stablecoin depends on the underlying asset and this explains why stablecoin prices tend to be stable while cryptos like Bitcoin and Ethereum have high volatility.
Another application of DeFi, which is mainly implemented using smart contracts, is credit markets. In the traditional financial system, banks and organizations check people’s profiles before granting them loans and credit. Often, several days are spent examining the person’s portfolio before the decision is made.
However, only people with a strong credit history are able to get the loans they apply for. In short, traditional lending services are not accessible or suitable for everyone. This is where DeFi comes in. Borrowing and lending is done through smart contracts and in a trustless manner, i.e. without any intermediaries.
This way, a large portion of the population can now take advantage of the lending option, even if people don’t have a strong credit history. Moreover, any lender can create a pool that can be used by borrowers to buy loans at interest rates defined by the lender and managed by the smart contracts. Previously, banks and other financial institutions dominated the credit markets by lending money to the public.
DeFi has not only opened the doors for borrowers, but also enabled crypto users to act as lenders, something that was previously impossible for many of them in the traditional financial system.
All activity that takes place on DeFi platforms is recorded on a public blockchain and can be easily verified. Aside from providing transparency, many of the world’s leading DeFi projects are open source, for example Uniswap. Because of this, people can easily replicate the code used by Uniswap and build a similar type of decentralized exchange for themselves.
Blockchain-enabled cryptocurrencies are not controlled by regulatory parties and are borderless payment solutions. They allow users to conduct global transactions securely and very conveniently in the shortest possible time for minimal transaction fees.
Compared to the existing centralized financial infrastructure, decentralized cryptocurrencies that are maturing and growing the decentralized financial ecosystem have proven to be a revolutionary innovation that is gaining mass appeal. So far, DeFi has provided access to other sophisticated and unattainable financial services to a majority of the population that does not have a bank account or a solid credit history.
This explains the potential and power of DeFi, a very hot topic in this field. Given the hype, more and more players are launching projects in the DeFi space and over time, more complex financial use cases are expected to be introduced in DeFi in a decentralized manner.
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