DeFi is an abbreviation of Decentralized Finance. Since it is decentralized, so it is very different from centralized finance. Defi uses the technology called blockchain, just like in cryptocurrency, to remove the third party access while processing any kind of financial activities like lending, borrowing, paying, saving, and many others. In the other words, the DeFi is aim to remove the bank intervention while doing financial services as described earlier.
Some features that DeFi offered for its users are listed below:
- Compound finance DeFi
- You can easily transfer funds in a matter of minutes, even seconds.
- It takes out the expenses that banks and other monetary organizations charge for utilizing their administrations.
- Anybody, anywhere, as long as there is an internet connection, can use DeFi without the approval of some third party (like a bank)
- You hold your cash in a safe computerized wallet as opposed to keeping it in a bank.
Understanding Decentralized Finance (Defi)
If you want to get to know decentralized finance deeper, comparing it with centralized finance is needed. Therefore, we should talk about centralized finance first.
In easy terms, centralized finance is the structure of finance where a third party financial service (like a bank) facilitates all the financial acts, indeed, intending to seek profit. In this case, your funds will be kept by the bank. The problem with this system is that centralized finance requires too many thirds parties to work well. The bank itself is a one-third party, and there are other third parties involved too.
Imagine when you want to buy cereal in a supermarket using your credit card, there is a total of 3 involved third parties in just buying a cereal. The first is the merchant that provides the credit card payment, the second is the bank to which your credit card belongs, and the third is the credit card network. Each party that facilitates your cereal payment receives payments for their services.
With all those involvements, just buying cereal requires extra funds, took a long time to accomplish, and we cannot deny the fact that sometimes it’s difficult to use the bank while traveling abroad.
Decentralized finance is the opposite of centralized finance. While centralized finance requires any third parties to complete any financial activity, decentralized finance eliminates them all. Thanks to the advanced technology called blockchain that allows this to happen. This system also uses the peer-to-peer network which uses connectivity, security protocols, hardware, and software advancements.
By using decentralized finance, anybody can make a financial transaction as long as they have an internet connection and a device to do that. You can trade, lend, or borrow using software that is capable to verify and also record the financial transaction in a database that is also distributed. This distributed database is also accessible through certain locations, it aggregates and collects data from all of the users. The framework uses the consensus mechanism to verify the transaction.
In the easy term, decentralized finance is made with the purpose to remove the centralized finance work structure. Decentralized finance aims to enable anybody to conduct financial services from anywhere they want without considering where and who they are.
Furthermore, decentralized finance offers the capability to take full control of personal funds using the digital wallet (cryptocurrency wallet).
One thing to understand that general individual misunderstood is that decentralized finance does not offer anonymity. Any transaction is recorded and any users can see the records in detail even though the record will not include your name.
How Does DeFi Work?
Decentralized finance uses the technology called a blockchain. Imagine there are many blocks with each block connected through a chain. Each financial transaction made is recorded in each block, and in every block, there is a user that verifies it.
If the user in a block agrees to verify the transaction, the transaction (the block) is closed and then encrypted which then creates another block. The previous block has the information about the transaction and so on until it reaches the final destination.
P2P (peer-to-peer) financial transaction is the main product of DeFi. The P2P DeFi transaction is where one party agrees to exchange cryptocurrency with the second party for services or goods without the involvement of a third party.
To understand well about this, you need to imagine when you want to borrow funds from a bank. (centralized finance). You go to the bank to get a loan, and if the bank approves your loan, then you will be given a loan using the lender’s fund. The difference is, in this case, you need to pay the interest and service fee to the bank.
In decentralized finance, you just need to DeFi yield farming and use dApp (decentralized application) and enter the amount of load you need. The system then uses an algorithm that will match up your loan need with suitable lenders. If you agree with the matched-up terms then you should get your loan very quickly.
This transaction of loaning and lending will be recorded and verified in a blockchain, which means that you will only receive the loan after the consensus mechanism verifies your transaction.
Since the DeFi itself is still under vast development, it is kinda difficult to determine which currency is used. One thing is for sure, the DeFi itself is designed specifically for the use of cryptocurrency. Some DeFi finances in recent times mostly use stable coin as the currency, it is a cryptocurrency that is backed by fiat currency like dollar 1:1.
The DeFi infrastructure is still in the early stages of development. Although it is considered the evolution of financial transactions, many questions rise should be answered until it is safe to use. As in the early evolution, the DeFi is still unregulated. This means that the DeFi ecosystem is still vulnerable, not to mention the risk of scams and hacks (because it is still unregulated).