Decentralized Finance (DeFi) is a system by which financial products become available on a public decentralized blockchain network. That makes these financial products open to anyone to use, rather than going through middlemen like banks, brokerages or exchanges. Unlike a brokerage account or bank, a government-issued ID, Social Security number, or proof of address are not necessary to use DeFi. More specifically, DeFi refers to a system by which software written on blockchains makes it possible for buyers, sellers, lenders, and borrowers to interact peer to peer or with a strictly software-based middleman rather than a company or institution facilitating a transaction.
Multiple technologies, services, and protocols are used to achieve the goal of decentralization. For example, a decentralized system can consist of a mix of open-source technologies, blockchain, and proprietary software. Smart contracts that automate agreement terms between buyers and sellers or lenders and borrowers make these financial products possible.
Regardless of the technology or platform used, DeFi systems are designed to remove intermediaries between transacting parties. DeFi platforms allow people to lend or borrow funds from others, speculate on price movements on a range of assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts. Some DeFi applications promote high interest rates but are subject to high risk. As of October 2021, the value of assets used in Decentralized Finance amounted to US $100 billion.
DeFi Use Cases
Using smart contracts, the following use cases for Decentralized Finance can be created:
- Decentralized exchanges (DEXes)
- Trading on DEXes and liquidity solutions
- Lending and borrowing
- Synthetic assets (derivatives)
- Prediction markets
- Staking solutions
- Asset management and wallets
- Insurance and risk hedging
- and more…
Layers of DeFi
You can think of Decentralized Finance in layers.
- Protocol: The blockchain network maintains the transaction history and stats of accounts.
- Assets: The native coin and other tokens and currencies using the respective blockchain.
- Smart contracts: The smart contract platform is necessary to perform automated contract execution and publication of tokens.
- Applications: Decentralized apps are software products that we use to control, manage, and access smart contracts.
DeFi solutions are not just offered on Ethereum, the world’s first smart contracts platform, but also a number of newer blockchain ecosystems.
About the Author
Michael Wutzke has more than 20 years of experience in IT. His focus is on the conception and development
of digital solutions on the Internet. Michael is currently working in finance in Frankfurt. More about the person
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