What is DeFi?

By: Yash, Peter, Zeneca

 

Decentralized Finance (DeFi) is a way to handle financial services, like borrowing, lending, or trading, without relying on traditional banks or financial institutions.

Instead, it uses blockchain technology (like Ethereum) to create a system where people can directly interact with each other to manage their money.

 

DeFi vs. traditional finance

Here’s a simple way to understand DeFi:

 

1. Imagine a world where you can lend or borrow money, trade assets, or even save for the future without having to go through a bank or a middleman. That’s what DeFi aims to achieve.
2. DeFi uses smart contracts, which are self-executing contracts with the terms of an agreement written into code. This helps automate financial services and ensures they run smoothly and securely.
3. DeFi allows people to participate in the financial world more easily, even if they don’t have access to traditional banking services. It also provides more control and transparency over your money.
4. DeFi applications can be used for various purposes, such as lending and borrowing platforms, decentralized exchanges, and more. 

Keep in mind that DeFi is still a relatively new concept, and while it has the potential to change the way we handle money, it also comes with risks. It’s essential to understand how it works and be cautious when using DeFi services.

TradFi (traditional finance) relies on middlemen. You need to rely on a bank to send money, earn interest, and get a loan. Banks make money by charging borrowers higher rates for loans than they pay you.

DeFi relies on code. You can send money, earn interest, and get a loan from users directly through smart contracts that enforce the rules. Unlike banks, many DeFi protocols are actually owned by the users (remember the own part of web3? Read, Write, Own). Users of DeFi protocols are sometimes rewarded by receiving crypto tokens that represent ownership or governance rights.

Think of it like earning a company’s stock as you use its products.

 

Let’s compare traditional finance to DeFi in more detail:

Trust

• TradFi: Middlemen like banks hold your money.
• DeFi: You hold your money and trust smart contracts to handle it.

 

Transparency

• TradFi: You can’t see the inner workings of banks or other middlemen.
• DeFi: Many DeFi protocols are open source.

 

Identity and access

• TradFi: You must apply for a bank account with your identity and credentials. Banks and markets are only open during business hours.
• DeFi: You can use DeFi protocols without revealing your identity as long as you have a crypto wallet. DeFi protocols work 24/7.

 

Returns

• TradFi: Middlemen take a large cut of your returns.
• DeFi: Returns are often higher due to more risk and fewer middlemen taking a cut.

 

Risk

• TradFi: Banks are federally insured and heavily regulated.
• DeFi: DeFi protocols are usually not insured or regulated (for now). Risks include volatile token prices, smart contract bugs, and scam projects.

 

As you can see, DeFi has both advantages and disadvantages compared to traditional finance:

Advantages include more transparency, greater access, and higher potential returns.

Disadvantages include higher risk associated with any nascent technology and industry.

You can use DeFi to send money to others, earn yield on your assets, provide liquidity / loans to others, acquire loans yourself, and much more. Visit our DeFi learning path to dive in and learn more if you’re interested.

 

In our next email, we’ll cover: “What is an NFT?”

Learn more:

• DeFi learning path (Odyssey)
• Defi & the future of Finance
• EXCELLENT video on “what is DeFI”