What Is Decentralized Finance (DeFi) In Simple Terms

Decentralized finance (DeFi) is one of the key trends in the cryptocurrency industry. The popularity of DeFi is constantly growing as decentralized finance covers the entire field of financial services and transactions. Let’s talk about the work of DeFi in more detail.

How decentralized finance (DeFi) works 

Decentralized Finance (DeFi) is an ecosystem of applications and services based on blockchains. Most applications run on the Ethereum blockchain. Along with this, more and more DeFi applications are being created on the BNB Smart Chain ( Binance Smart Chain ) blockchain.

In general, DeFi is the usual financial instruments but built on the basis of the blockchain. As a rule, DeFi applications are created using open-source smart contracts.

In addition to smart contracts, decentralized finance (DeFi) uses digital asset technologies, and decentralized applications (DApps). DeFi technologies allow you to create irreversible agreements without intermediaries (banks or government bodies).

Some DeFi applications allow the creation of stablecoins. These are cryptocurrencies pegged to the value of fiat currencies (for example, Tether USDT is pegged to the US dollar).

Most decentralized finance (DeFi) applications operate on a peer-to-peer (P2P) basis. In such a system, users interact with each other without the involvement of intermediaries. Compliance with the terms of the transaction is ensured by a smart contract, and the users themselves are responsible for their funds.

Also Read: Web 3.0 and Metaverses: The New Decentralized World in Practice

Key Applications for DeFi

As already mentioned, DeFi allows you to create stablecoins pegged to fiat currencies. Also in the field of DeFi there are platforms that issue tokenized shares. In fact, these are traditional shares, but with the advantages of the blockchain.

In addition, the field of decentralized finance allows the creation of decentralized exchanges (DEX) of cryptocurrencies. Such exchanges do not store users’ funds and their personal data. The KYC procedure for trading is not required, which ensures the complete anonymity of the participants. At the moment, the most popular DEX exchanges are Uninswap on the Ethereum blockchain and PancakeSwap on the BNB Smart Chain blockchain.

Advantages and disadvantages of DeFi

The main advantage of decentralized finance is its general availability and openness. There are no centralized management structures; smart contracts are responsible for ensuring operations. In addition, DeFi has the following advantages:

• open source provides transparency and public nature of transactions;
• DeFi applications and services can be used by any user;
• Anyone can create a DeFi application;
• new applications can be created by combining other DeFi projects.
  

Control over the ecosystem is distributed among all network members. In addition to smart contracts, DeFi services are governed by voting. Transactions are completed quickly and without a chain of intermediaries, which reduces commission costs. However, decentralized finance also has disadvantages related to:

• systemic risks: liquidity and credit risks;
• high volatility: with a sharp drop in the price of underlying assets blocked in the CDP, there is a mass liquidation of assets, which is fraught with a collapse of the system;
• the risk of hacking smart contracts;
• data flow centralization;
• lack of funds in DeFi loans.

In the field of decentralized finance, the lines of responsibility are blurred. There is no controlling body, so no one is responsible for what happens inside the ecosystem. To be precise, the community itself is responsible. The unwillingness of ecosystem participants to participate in the development of the service may adversely affect the functioning of the project.

At the same time, some DeFi projects are faced with the problem of control over development by one team. As a rule, the problem manifests itself at the moment of delegating responsibility from the developers to the community.

Conclusion

In the future, the development of decentralized finance (DeFi) can provide an open financial system without intermediaries and corruption. Despite the fact that this is a relatively new segment of the cryptocurrency market, it is quite well developed. At the same time, the pace of development is constantly gaining momentum.