What is DeFi? A beginner’s guide to decentralized finance

DeFi products make financial services available to all those with an Internet connection, and they are mostly held and supported by their users. To date, dozens of billions of dollars in cryptocurrencies have passed through DeFi apps, and that number is growing on a daily basis.

What Is DeFi?

DeFi, abbreviated from decentralized finance, is a new concept for banking and financial services built primarily on peer-to-peer (that is, straight between two people rather than via a centralized system) transactions using blockchain technology. Based on blockchain, DeFi enables transactions bypassing traditional financial intermediaries like banks or brokers.

You can get the majority of banks' services through DeFi - earn interest, lend, borrow, purchase insurance, trade derivatives and assets - but it's faster and requires no paperwork or third-party involvement.

DeFi was developed to become an alternative to traditional financial services. To be more specific, DeFi consists of smart contracts (self-executing codes that run at a specific address on the Ethereum blockchain), which then enable decentralized applications (dApps) and protocols. Most of the original DeFi applications were created on Ethereum, and much of the total value locked (TVL) of the ecosystem is still centered there.

Before the idea of decentralized finance became known, it was often referred to as "open finance."

How Does DeFi Work?

DeFi, while often associated with cryptocurrencies, steps even beyond the production of new digital currency or value. DeFi's smart contracts are intended to replace traditional financial services.

DeFi delivers financial services that reduce the need for third parties like brokers. These services include lending (when users can lend their cryptocurrency and receive interest within minutes instead of once a month), obtaining instant loans, making peer-to-peer transactions with no broker, saving cryptocurrency and getting a higher interest rate than in a bank, and purchasing derivatives like stock options and futures contracts.

No banks or institutions control the money as there are no intermediaries to empower transactions for DeFi applications. In addition, the code is available for anyone to examine, so DeFi protocols have a sense of transparency. There are also open networks that cross national borders. Numerous applications are accessible to users, mostly based on the Ethereum blockchain.

Why Is DeFi Important?

DeFi brings a profound breakthrough in the way people deal with finance and expands access to that world for anyone who is interested. Its importance lies in the fact that centralized systems and human gatekeepers can restrict the pace and complexity of transactions, giving users less direct control over their funds. DeFi is special since it widens the use of blockchain from simple price transfers to more complicated financial cases.

DeFi takes the core bitcoin premise - digital money - and adds to it, establishing a whole virtual equivalent to Wall Street, but without all the costs involved (such as office towers, marketplaces, banker wages, etc.). This could lead to more open, free, and fair financial markets, available to anyone with an Internet connection.

How Does DeFi Differ From Traditional Banking?

The traditional banking field (aka TradFi) relies on KYC - know your customer - the procedures financial entities use to verify a customer's identity and legitimacy prior to entering into business with them. Briefly, the client has to prove they are the person they claim to be.

To borrow money from a bank, you will need a credit check, proof of identity and probably an income verification. With DeFi, however, the client can often remain anonymous and choose to keep their identity and personal information private. All you normally need is digital assets.

Rather than getting through financial institutions, DeFi members conclude a "smart contract", a computer code that functions as a mediator, ensuring that everyone meets their obligations.

The Benefits of DeFi

For individuals, the advantages of DeFi include potentially lower fees, a wider range of services, and the opportunity to generate greater income through their cryptocurrencies. DeFi security is another major factor. These and some more benefits are provided by decentralized applications developed by various groups.

Decentralized applications, or dApps, enable users to make capital transfers worldwide (with fast settlement and for low cost), peer-to-peer borrowing and lending, exchange of cryptocurrencies, NFTs and other services such as crypto-wallets and storage solutions.

Some Other Benefits of DeFi

Open: No need to submit an application or 'open' an account. You simply obtain access once you have created a wallet.

Anonymous: Your name, email address or any personal information is not required.

Flexibility: Relocate your assets anywhere and anytime without needing permission, waiting so long for the transfer to complete or facing costly fees.

Fast: Interest rates and rewards are often updated quickly (as fast as every 15 seconds), and can be considerably faster than traditional Wall Street.

DeFi Risks and Ways to Handle Them

Along with all these benefits, DeFi contains some risks. DeFi funds may be an attractive target for attackers. To prevent this, there are audits that enhance the security of DeFi.

DeFi smart contract audit is a process that was implemented into the crypto world to ensure the security of the DeFi space. People with developing experience conduct audits of contracts to verify that they are secure for a common investor. Hexens is a cybersecurity boutique, which conducts deep dives and thorough audits.