DeFi is shorthand for ‘Decentralized Finance’, an umbrella term for an alternative financial system without third-party institutions or government holding a monopoly, built on the blockchain.
The Long Explanation
DeFi is an emerging distributed financial technology that applies all of the underlying principles of the blockchain to an alternative financial system.
Decentralized Finance applications are built on the principle that no third-party institutions or governments should have monopolistic control over the world’s money or financial services/products.
A typical DeFi system is, thus, devoid of third-party involvement, while providing most of the services provided by banks. This includes everything from borrowing, lending, trading derivatives, trading assets, and earning interests, among others.
Like all of crypto, it adopts a global, decentralized peer-to-peer system, meaning transactions are conducted directly between two people with little or no involvement from a third party. It is also pseudonymous and open to all.
DeFi systems are attractive to many for a variety of reasons. For starters, it eliminates the voluminous paperwork and bureaucracy associated with traditional banking. It is also a more transparent system as everyone involved in a transaction can view its details on the blockchain.
Decentralized systems also eliminate the fees associated with traditional financial institutions, hand over control of your financial assets to you (via a secure digital wallet), improves transaction flexibility for anyone with a device and an internet connection, and speeds up transaction confirmation.
Most DeFi systems today are built on the Ethereum blockchain, taking advantage of its support for decentralized software. The applications employ smart contracts to facilitate transactions without human intervention.
As an emerging technology, the function and advantage of DeFi is still a hotly debated topic. Many commentators, though, are of the opinion that DeFi would shape the future of financial services.
A wide variety of decentralized finance applications have been built today on the blockchain. These applications can generally be grouped into:
- Stablecoins: A special type of cryptocurrency whose value is tied to the value of a stable asset. In most cases, this asset is a fiat currency such as the US dollar, but stablecoins may also be linked to other cryptocurrencies or precious metals.
- Decentralized Exchanges (DEX): Peer-to-peer blockchain technologies designed to facilitate the swapping or transfer of crypto assets.
- Lending services: Financial services that enable crypto holders lend out their crypto for interest, or get an instant loan without having to file extensive paperwork.