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What is Decentralised Finance or “DeFi”?

A blockchain-based form of finance with no reliance on the need for traditional financial instruments.

Decentralised Finance, or DeFi, is an umbrella term for the financial services on public blockchains, but primarily Ethereum. DeFi is a faster way to do most things that banks support: earning interest, borrow, lend, buy insurance, trade assets, and trade derivatives. DeFi doesn’t require any paperwork or a third party. As with digital assets, DeFi is a global peer-to-peer financial system — i.e. DeFi works directly between people and doesn’t need to go through extensive systems unlike traditional finance.

Is DeFi important?

DeFi takes the basic premise of digital asset management and expands on it. DeFi has found a way to digitise and optimise an easier way to invest without the concrete jungle housed by wall street brokers. It produces the same quality service (arguably better) with no associated costs. DeFi has the potential to create more open, free, and fair financial markets that are accessible to anyone with an internet connection. DeFi can provide instant transactions with no alternative costs for service.

What are the benefits?

Open

You don’t need to apply or “open” an account to start using DeFi applications. You gain access by creating a wallet.

Transparent

Everyone involved can see the full set of transactions, unlike private corporations that rarely grant this kind of transparency.

Pseudonymous

You don’t need to provide your name, email address, or any personal information.

Flexible

You can move your assets anywhere at any time, without asking for permission, waiting for long transfers to finish, or paying expensive fees.

Fast

Interest rates and rewards often update rapidly and can be significantly higher than traditional Wall Street.

How does it work?

DeFi are financial services with no central authority. They involve taking traditional elements of the financial system and replacing the middle man with a smart contract. DeFi needs a decentralised infrastructure to work on to be able to run. This is where Ethereum comes into the picture. Ethereum is the world’s second-largest online currency platform which sets itself apart from the Bitcoin platform in that it’s easier to use to build other types of decentralised applications beyond simple transactions. These more complex financial use cases were even highlighted by Ethereum creator Vitalik Buterin back in 2013 in the original Ethereum white paper.

That’s because Ethereum’s platform for smart contracts ensures that your service is executed immediately when certain conditions are met. This offers so much flexibility in terms of transactions. Ethereum programming also offers languages such as Solidity, which are specifically designed for creating and deploying smart contracts. For instance, let’s say a user wants to transfer money at 5pm on a Wednesday, November 2023, such rules can be written in a smart contract.

With smart contracts at their core, dozens of DeFi applications are operating on Ethereum, some of which we explore below. Ethereum 2.0 a coming upgrade to Ethereum’s underlying network, could give these apps a boost by chipping away at Ethereum’s scalability issues.

The most popular types of DeFi applications include:

Decentralized exchanges (DEXs)

Online exchanges help users exchange currencies for other currencies. DEXs are a hot type of exchange, which connects users directly so they can trade digital assets currencies with one another without trusting an intermediary with their money.

Prediction markets

Markets for betting on the outcome of future events, such as elections. The goal of DeFi versions of prediction markets is to offer the same functionality but without intermediaries.

“Wrapped” Bitcoins (WBTC)

A way of sending Bitcoin to the Ethereum network so the Bitcoin can be used directly in Ethereum’s DeFi system.

Stablecoins

A digital asset that’s pegged to a fiat asset (the dollar or euro, for example) to stabilise the price.

Lending platforms

These platforms use smart contracts to replace go-betweens, such as banks that manage lending in the middle.

In addition to these apps, new DeFi concepts have sprung up around them too

Money lego

Putting the concept “composability” another way, DeFi apps are like Legos, the toy blocks children click together to construct buildings, vehicles, and so on.There are tech stocks that allow you to move or fit various applications into projects. DeFi apps can be similarly snapped together like “money legos” to build new financial products.

Liquidity mining

When DeFi applications entice users to their platform by giving them free tokens. Offering free tokens is one of the most successful yield-farming techniques (see below).

Yield farming

For knowledgeable traders who like to gamble, there’s yield farming, where users browse through various DeFi tokens in search of opportunities for large returns.

Composability

DeFi apps are open source, meaning these apps can be used to compose new apps with the code as building blocks. Open source is when the code used within an app can be viewed by anyone.

More about lending platforms

Lending markets are one of the topics under the DeFi umbrella, which connects borrowers to lenders of digital assets currencies. Compound allows users to borrow digital assets and offer their own loans. Users can make money from the interest of lending out their money. Compound processes the interest rates algorithmically, so if there’s higher demand to borrow a digital asset, the interest rates will increase.

DeFi lending is collateral-based too, meaning in order to take out a loan, a user needs to put up collateral — often Ether, the token that powers Ethereum. That means users don’t give out their identity or associated credit score to take out a loan (which is how normal, non-DeFi loans operate).

More about stablecoins

A stablecoin is another very useful DeFi application. Digital assets often experience wild price fluctuations. This isn’t good for people who want to know how much their money will be worth in a week — or even a few days. Stablecoins peg digital assets to specific fiat currencies and track their value to help maintain stability in the digital assets market (just as their name implies).

Buy, sell, and transfer digital assets with the Baanx App

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