What is Defi?
In its simplest form, decentralized finance is a system by which financial products become available on a public decentralized blockchain network, making them open to anyone to use, rather than going through middlemen like banks or brokerages. Unlike a bank or brokerage account, a government-issued ID, Social Security number, or proof of address are not necessary to use Defi.
The use of technology in financial services is not new. Most transactions at banks or other financial services companies are accomplished with the help of technology nowadays. However, the role of technology is restricted to being a facilitator of such transactions. Companies still have to contend with navigating the legalese of jurisdictions, competing for financial markets, and different standards to make a transaction possible. With its stack of common software protocols and public blockchains to build them on, DeFi places technology at the front and center of transactions in the financial services industry.
DeFi is commonly placed in the domain of blockchain and cryptocurrencies. But its scope is much wider. To understand the thought processes that led to the development of decentralized finance, it is important to understand the current state of the finance ecosystem.
How does defi work
DeFi uses cryptocurrencies and smart contracts to provide services that don’t need intermediaries. In today’s financial world, financial institutions act as guarantors of transactions. This gives these institutions immense power because your money flows through them. Plus billions of people around the world can’t even access a bank account.
In DeFi, a smart contract replaces the financial institution in the transaction. A smart contract is a type of Ethereum account that can hold funds and can send/refund them based on certain conditions. No one can alter that smart contract when it’s live – it will always run as programmed.
A contract that’s designed to hand out an allowance or pocket money could be programmed to send money from Account A to Account B every Friday. And it will only ever do that as long as Account A has the required funds. No one can change the contract and add Account C as a recipient to steal funds.
Contracts are also public for anyone to inspect and audit. This means bad contracts will often come under community scrutiny pretty quickly.
This does mean there’s currently a need to trust the more technical members of the Ethereum community who can read code. The open-source-based community helps keep developers in check, but this need will diminish over time as smart contracts become easier to read and other ways to prove the trustworthiness of code are developed.
In summary, DeFi is an open and global financial system built for the internet age – an alternative to a system that’s opaque, tightly controlled, and held together by decades-old infrastructure and processes. It gives you control and visibility over your money. It gives you exposure to global markets and alternatives to your local currency or banking options. DeFi products open up financial services to anyone with an internet connection and they’re largely owned and maintained by their users. So far tens of billions of dollars worth of crypto has flowed through DeFi applications and it’s growing every day.