A Comprehensive Guide to Decentralized Finance: DeFi
Decentralized finance has been making waves for a while now. If you’re someone interested in the crypto world, you’ll likely have heard about the development of decentralized finance over the years. Many experts and traders liken it to the Initial Coin Offering (ICO) craze of 2017. All you have to do is glance at some internet forums or scroll through your social media, and you’ll see people touting decentralized finance as the next big thing.
However, despite its popularity, the reality is that most people don’t understand what decentralized finance is or what it entails. In many people’s eyes, decentralized finance is one of the biggest successes of blockchain technology. According to DeFi Pulse, people had only put $1 billion for use in DeFi technology. However, since then, the number has increased substantially. In April 2021, the total value of DeFi protocols exceeded $50 billion. Since then, the DeFi train has shown no signs of stopping.
Naturally, reading these figures might have piqued your curiosity about decentralized finance. Let’s look at decentralized finance and everything you need to know about it.
Various cryptocurrency tokens
What is Decentralized Finance (DeFi)?
Decentralized finance refers to blockchain protocols ushering in a new era of financial services. Decentralized finance uses blockchain technology like smart contracts to eliminate intermediaries like banks, accountants, lawyers, etc. As a result, decentralized finance provides open access to financial services. Numerous applications exist within the DeFi sphere. Each of them offers users different options. For instance, users can currently use DeFi technology for lending and borrowing, spot trading, margin trading, derivative trading, and insurance. Ultimately, decentralized finance aims to replace traditional financial service providers.
The Difference Between DeFi and Traditional Finance
Decentralized finance continues to thrive because it offers an alternative to traditional finance. DeFi operates on the principles of eliminating the inefficiencies of traditional finance methods. As a result, numerous differences exist between the two.
For instance, let’s assume you’re using a traditional financial service provider like a bank. You’ll have to share sensitive data to open an account. Every time you make a payment or a transaction, your bank will need to approve it before it can occur. In addition, the bank will charge you transaction fees for making these payments. In many instances, clearing and settling transactions can also take time. As a result, you have to jump through several hoops when dealing with traditional financial service providers.
However, that’s not the case with decentralized finance technology. Let’s assume you want to lend money to another person using DeFi. For starters, you don’t have to share any personal information with each other. All you’ve got to do is connect your digital wallet with the other persons, and you’re ready to make transactions. You can complete transactions without requiring approval from an intermediary. Moreover, transactions are quick because they happen in near real-time. As a result, decentralized finance makes transactions simpler for users.
DeFi accomplishes this through smart contracts. Essentially, smart contracts are digital agreements recorded on the blockchain. These contribute to some of DeFi’s game-changing qualities.
Ethereum ornament on a chess board
DeFi’s Salient Qualities
Here are some of DeFi’s salient qualities. These make it a revolutionary technology. They include:
· No Authorization: DeFi protocols enable anyone to interact with them. Users don’t need any authorization to use DeFi protocols. Nor do they need approval from an intermediary.
· Composability: Different DeFi technologies can interact together. As a result, users enjoy increased functionality not available in traditional finance.
· No Censorship: Since DeFi protocols are open-source, censoring transactions is impossible.
· Immutability: Changing the code of DeFi protocols is challenging and unviable once they’re in use. As a result, users can rest easy knowing that applications will function the same way.
· Transaction Fees: DeFi eliminates intermediaries. As a result, you don’t have to pay transaction fees and other costs like you usually would.
· Transparency: All DeFi transactions are recorded on the blockchain. As a result, anyone can view them. Users don’t have to worry about intermediaries breaking their trust.
DeFi Ecosystems
Numerous ecosystems exist within the DeFi sphere. They include:
Ethereum
Many people know Ethereum as the world’s second-most valuable cryptocurrency. However, they often gloss over its blockchain network. Ethereum’s blockchain is well-known for being robust, but more importantly, it was the first to include a programming language that facilitated drafting smart contracts. As a result, Ethereum’s blockchain network has become the focal point for many DeFi applications. Statistics corroborate these claims. According to data from DeFi Prime, there were 251 operational DeFi projects in April 2021. Out of those, 215 were operating on Ethereum’s blockchain technology. Hence, it’s apparent that Ethereum is the dominant network for DeFi.
Non-Ethereum Networks
While Ethereum remains the dominant network for decentralized finance technologies, other blockchain networks also have prospering DeFi ecosystems within them. Many of these blockchain networks were created to address the problems with Ethereum’s blockchain network. For starters, one of the most commonly cited issues with Ethereum’s blockchain is the high transaction fees. Ethereum’s network aims to maximize decentralization. As a result, it requires incentivizing several transaction validators. In addition, Ethereum’s network also limits the number of transactions within a single block. It does this to reduce hardware demands. However, as Ethereum’s network adoption increases, things become challenging. It results in blocks reaching their maximum capacity. Therefore, users have to endure long waiting times. Or they can outbid other users to make their transactions work. However, the latter option contributes to increased transaction fees.
Some alternative blockchains to Ethereum include:
· Polkadot: Polkadot’s blockchain technology makes it easier for users to launch their customized blockchains. These are known as parachains.
· Cardano: Cardano’s blockchain prides itself on being the world’s first peer-reviewed smart contract network with a proof-of-stake concept.
· Tron: Tron aims to address Ethereum’s blockchain inefficiencies. It has fewer designated transaction validators. These help reduce transaction costs and increase speed.
· Solana: Solana’s blockchain has several features missing in other blockchains. These include a consensus mechanism, data storage, and transaction broadcasting.
· Avalanche: Avalanche’s blockchain network focuses on interoperability.
A cryptocurrency trader
Eschew Traditional Finance with Crystal Ball Markets
Decentralized finance continues to become more popular. Many experts argue decentralized finance will mark the end of traditional financial service providers in the future. While the validity of that claim remains to be seen, DeFi is progressing exponentially.
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