What Is DeFi?

DeFi, or decentralized finance, is a broad term encompassing applications and projects in the public blockchain space that aim to challenge traditional finance. Being global, peer-to-peer (meaning directly between two people), and pseudonymous, DeFi offers the same possibilities as banks do and then some. Earning interest, borrowing, and trading assets – it’s all done faster, with no tedious paperwork required, and in the end, the user is the sole owner of their funds.

How Does DeFi Work?

DeFi services are accessed through financial applications built on blockchain technologies called decentralized apps (dApps). To ensure the integrity of the interactions between individuals, dApps use smart contracts – automated agreements that can be executed without intermediaries. The ability of smart contracts to reduce the formality and costs associated with traditional methods without compromising on authenticity and credibility makes them an ideal choice for building financial applications. Most dApps are currently set up on the Ethereum network, but other public blockchain networks are emerging that provide enhanced speed, scalability, and security.

So far, the most common use cases for DeFi have been trading, earning interest through liquidity provision and lending, and borrowing. However, there's much more to DeFi, and the range of available services is constantly growing.

Trading

Smart contract-based decentralized exchanges (DEXs), such as Uniswap, are a great example of a DeFi use case. DEXes offer users the opportunity to trade cryptocurrencies smoothly and autonomously without needing a third party to facilitate the transfer and custody of funds.

Earning Interest

To earn passive income through DeFi, investors can either provide liquidity to a DeFi protocol (called yield farming) or lock their assets on the blockchain for a limited time (called staking). In either case, the assets can generate a sizable yield for the investors on protocols such as Compound and Aave.

Borrowing

Borrowing on dApps, such as Uniswap, works similarly to borrowing from a traditional bank, but it is typically faster, cheaper, and more accessible. To borrow on a dApp, a user typically needs to provide collateral as a cryptocurrency or another digital asset. Once done, the loan is approved, and the user receives the borrowed funds.

Lending

Unlike traditional banks, DeFi lending allows individuals to easily lend their assets to others and earn interest on the loan. Users who want to become lenders can deposit their coins into DeFi protocol-based smart contracts like Compound, Uniswap, and others.