Decentralized Finance And How It Works

An emerging digital financial infrastructure de-fi eliminates the need for a centralized institution such as a bank to approve financial transactions. Rather than running on a single server, decentralized finance refers to a financial system that operates on a decentralized network of computers. Many people perceive de-fi as a general term referring to a new range of innovation in financial services deeply connected with blockchain, the underlying technology of bitcoin.

Blockchain is an immutable and decentralized public ledger on which bitcoin and other cryptocurrencies are based. It enables all computers on a network to keep a copy of the history of transactions, and no single authority can control or alter the ledger of these transactions.

How Is The Ethereum Network Linked To De-Fi?

Most of the financial services defined as de-fi are based on the Ethereum network. Ethereum is the second-largest crypto in the market after bitcoin, and its network serves as a platform that allows the creation of other blockchain apps.

Through decentralized apps, two or more parties can exchange, lend, borrow or trade directly using the blockchain and smart contracts without intermediary and transaction costs. In other words, it is a free, fair, and opens digital marketplace.

Bitcoin Vs. De-Fi

There is a difference between bitcoin and de-fi. Bitcoin is a decentralized digital coin operating on blockchain technology and is mainly used as a store of value.

In contrast, defi describes financial services built on public blockchains like bitcoin and Ethereum enabling users to earn interest and borrow against their crypto holdings. De-fi has many applications revolving around financial services such as borrowing, lending, trading, and derivatives.

How Defi Works

Alex Gierczyk, a de-fi enthusiast, explains that decentralized finance utilizes cryptocurrencies and smart contracts to offer financial services eliminating the need for mediators like guarantors. Such financial services include:

·        Peer-to-peer trading without an intermediary.

·        Buying derivatives like stock options and futures contracts.

·        Lending cryptos for interests in minutes rather than once a month.

·        Receiving loans instantly.

·        Saving cryptos and earning better interests than banks.

D-apps, most of which are found on the Ethereum network, help users implement peer-to-peer transactions. Most commonly used de-fi services and d-Apps include stable coins (their value are pegged to a fiat currency), coins like ether, digital wallets like Coinbase, tokens, de-fi mining, trading, staking, yield farming, lending, borrowing, and saving using smart contracts.

Since defi is an open book, users can inspect and innovate upon its protocols and apps. They can even mix and match protocols to develop their d-Apps.

What More Can You Do With De-Fi?

Other than using cryptos and smart contracts to provide financial services, the possibilities of de-fi continue to expand. more uses include:

·        Storing money in crypto wallets.

·        Trading cryptos anonymously at any moment.

·        Sending money internationally affordably and quickly.

·        Borrowing and lending on a peer-to-peer level.

·        Trading tokenized forms of investments like stocks and NFTs.

·        Buying insurance.

·        Crowdfunding.

The Takeaway

Like cryptos, de-fi is risky, especially if you use new technology. The risk is even higher for beginners lured by the potential gains of passive income and yield farming, so you should perform your due diligence beforehand.

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