An acronym for "Decentralized Finance" and an umbrella term for Ethereum and blockchain applications. DeFi is an emerging technology that helps recreate financial services with blockchain technologies. It allows users to make purchases and transfer funds without the use of a middleman and entitles them to hold a copy of transactions.
For instance, when you make a purchase in an eatery and pay the price of the product you purchased. There is a financial institution sitting between you and the business that takes control over the transaction, like a bank or a third party. That middleman is cut out in DeFi. There is no brokerage, exchange, or financial institution involved in the ecosystem.
As DeFi uses blockchain technologies, nothing is controlled by a single source. It gives its users complete control over their finances without much paperwork or personal information. Everything is done over a smart device called a "smart contract" with an internet connection. Smart contracts in DeFi with the internet handle intermediate transactions.
Elements of Decentralized Finance (DeFi)
In order to process a transaction, there are several elements and layers that dictate the specific function of the app. It also helps provide, secure, and manage transactions across the infrastructure.
- Settlement layer: Also known as layer 0, the settlement layer is considered the foundation of the DeFi infrastructure. The layer consists of a public blockchain network and a specific cryptocurrency that together supports the transactions.
- Asset layer: It is the layer that includes all the digital assets and tokens that are native to a particular blockchain.
- Protocol Layer: As every transaction in the DeFi ecosystem must adhere to the set rules and regulations, the protocol layer contains all the agreed rules, services, and others for smart contracts.
- Application layer: The front-facing or consumer-facing part of DeFi is what the application layer consists of. It helps bring the protocol layer to life with a user interface.
- Aggregation layer: The layer of aggregation is all about how all the services in the application layer provide a seamless transaction experience. It includes aggregators that connect the dApps and protocols that function as the foundation of borrowing, lending, and other services.
How does DeFi work?
As DeFi allows people to transfer money, secure a loan, invest in derivative stocks, and engage in other financial activities all by themselves, DeFi uses cryptocurrencies and smart contracts to facilitate the transactions and eliminates the need for intermediaries like a bank manager, brokers, guarantors, or any other middle agent. Smart contracts are program codes that replace intermediaries and process a transaction once both parties satisfy the conditions in the smart contract.
Use case of DeFi
With smart contracts and the ability of Ethereum to create applications, DeFi is gaining popularity and is being successfully used in several ways. The most common use cases for DeFi are:
- Lending network: DeFi is used by financial institutions and other businesses as a lending network that offers peer-to-peer borrowing and lending.
- Decentralized exchange: DeFi is used for decentralized exchanges from one type of currency to another. For instance, a decentralized exchange includes trading ether for US dollars.
- Stablecoins: DeFi is used as a stablecoin that connects a type of cryptocurrency with one or more traditional types of currency.
Prominent examples of DeFi apps
In the field of the financial market, there are several examples of DeFi apps used in creative ways, like:
- Aave: It is a decentralized landing protocol that provides liquidity and equal opportunity for borrowers and lenders. It helps lenders borrow the minimum collateral and earn rewards.
- Badger: Badger helps DeFi bring Bitcoin into the DeFi market. It helps users deposit bitcoins into different products of exchange.
- Bancor: It offers a peer-to-peer cryptocurrency swap mechanism to its users without going through a centralized exchange.
- Uniswap: A crypto trading platform that allows users to buy and increase the liquidity in the market. It lets users trade between ETH and ERC-20.
- Synthetix: It allows investors to participate in global markets, stocks, and commodities and also helps create digital assets called synths. Synthetix is said to introduce the future of broker-less trade exchanges.
DeFi's expected benefits and drawbacks
The DeFi ecosystem is built and governed by programme code. The core of the DeFi ecosystem lies at the heart of blockchain technologies like smart contracts and Ethereum. As the rising popularity of DeFi makes it look like a great investment, before you step in, it is essential to know all the related pros and cons of DeFi.
Pros of DeFi
- Zero intermediaries between transactions.
- It offers more accessibility for loans and insurance.
- Offers a higher rate of interest.
Cons of DeFi
- As there is no governing body, losing or forgetting important details can lead to the loss of assets.
- Lack of consumer protection.
- High risk and volatility.
What does the future hold for DeFi?
There is no denying that the rapid growth of DeFi is thriving the industry, but it may be too soon to predict or pass judgement on DeFi's net effect on the future of finance. For now, DeFi is the hype of the crypto space and is expected to grow. With the advancement of blockchain development in the field of the crypto world, De-Fi is also taking over the concept of the traditional financial system and is ensuring easier and more secure financial transactions like transfers, lending, investing, saving, trading, and others. Reviewing the diverse use cases of DeFi now, you can get a secure, scalable, and robust DeFi platform developed by Mrmmbs Vision, the Best Blockchain Development Company in Delhi.
