What is DeFi?

2021-03-05 | CryptoCurrency.org

DeFi stands for Decentralized finance. DeFi is a public financial infrastructure / system based on digital devices, procedures, smart contracts and decentralized applications (DApps), mainly in the Ethereum blockchain.

The essence of DeFi

DeFi's aim is to provide tangible, everyday financial services on a blockchain basis, leveraging the potential of technology. Following the release of Bitcoin in 2009, the only purpose of various blockchain systems was to allow the movement and transfer of a single cryptocurrency. Satoshi Nakamoto's work was capable of much more, however, as it happened in the Ethereum system.

The essence of DeFi is to allow complex financial transactions between several actors through smart contracts; lending is a great example of this. It is, in fact, much more than “just” moving a digital device, a cryptocurrency, since each DeFi lending project works with liquidity pools that are charged by the users, who receive interest, i.e. a commission for their contribution. The interest rate is determined by the system, but not arbitrarily: it is continuously adjusted to the current rates of supply and demand. A decentralized exchange (DEX) operates on a similar principle, with the difference that the goal here is not to take out borrowing, but to take advantage of changes in exchange rates. Here, too, liquidity reservoirs need to be replenished for users to create trading opportunities in the system.

The most popular types of DeFi applications are the following:


New DeFi concepts that have emerged due to the DeFi apps

  • yield farming: this is for knowledgeable traders who are not afraid of taking risks. Here, users scan through various DeFi tokens in search of opportunities for larger returns.
  • liquidity mining: this happens when DeFi applications entice users to their platform by giving them free tokens. This has been the hottest form of yield farming so far.
  • composability: DeFi apps are open source, i.e. the code inside of them can be viewed and modified by anyone. Therefore, these apps can be used to "create" new apps with the code as its building blocks.
  • money legos: DeFi apps work like legos, the toy blocks children click together to construct buildings and other objects. DeFi apps can be similarly snapped together like "money legos" to build new financial products.

Is investing in DeFi safe?

No, it’s still risky, although many believe DeFi is the future of finance and that investing in the disruptive technology early could lead to massive gains. As DeFi has increased in activity and popularity through 2020, many DeFi applications, such as meme coin YAM, have crashed and burned, sending the market capitalization from $60 million to $0 in approximately 35 minutes. Other DeFi projects, including Hotdog and Pizza, faced the same fate, and many investors lost a lot of money.


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