What is Decentralized Finance?

Decentralized Finance (DeFi) is a system by which financial products become available on a public decentralized blockchain network. That makes these financial products open for anyone to use, without going through middlemen like banks, brokerages or exchanges. Unlike with a brokerage account or a bank, no government-issued ID, Social Security number, or proof of address is necessary to use DeFi. More specifically, DeFi is a system in 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, with no company or institution facilitating the 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 of a range of assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts. Some DeFi applications advertise high interest rates but carry high risk. As of October 2021, the value of assets used in Decentralized Finance amounted to US$100 billion.

DeFi use cases

With smart contracts, the following use cases for Decentralized Finance can be built:

• 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
• Oracles
• and more…

Layers of DeFi

You can think of Decentralized Finance in layers.

• Protocol: The blockchain network maintains the transaction history and the state of accounts.
• Assets: The native coin and other tokens and currencies that use the respective blockchain.
• Smart contracts: The smart contract platform is needed for automated contract execution and the issuing of tokens.
• Applications: Decentralized apps are software products that we use to control, manage, and access smart contracts.

DeFi solutions are offered on Ethereum, the world’s first smart contract platform, and also on a number of newer blockchain ecosystems.