DeFi — short for decentralized finance — is a new vision of banking and financial services that is based on peer-to-peer payments through blockchain technology. Via blockchain, DeFi allows “trust-less” banking, sidestepping traditional financial middlemen such as banks or brokers.
What’s in it for investors? DeFi promises to allow investors to “become the bank” by giving them opportunities to lend money peer-to-peer and earn higher yields than those available in traditional bank accounts. Investors can also send money quickly anywhere around the world, and they can access their funds via digital wallets without paying traditional banking fees.
Here’s how DeFi operates, how it can benefit individuals, how it challenges traditional banking and the risks it presents.
How DeFi works
The goal of DeFi is to provide many of the financial services that customers and businesses currently enjoy — loans, interest on deposits, payments — but to use decentralized technology to do so. In effect, DeFi changes the industry not so much by changing the what but rather the how. That is, DeFi creates new infrastructure to deliver similar financial products and services.
To do so, it uses blockchain technology and smart contracts, among other tools. Blockchain is a kind of ledger technology that tracks all transactions on a given financial platform. Think of it as a running record of all transactions on that specific blockchain, chronologically recorded. If Person A pays money to Person B, that would be timestamped permanently in the ledger.
“The building blocks of DeFi are smart contracts, which are executable codes that can store cryptocurrencies and interact with the blockchain according to its rules,” says Oleksandr Lutskevych, CEO and founder of CEX.IO, a firm that facilitates DeFi and cryptocurrency.
To enable DeFi, smart contracts automatically execute transactions among participants. When the contract’s conditions are fulfilled, they self-execute their set of instructions.
“DeFi allows for smart contracts on the blockchain to take the place of trusted intermediaries — such as banks or brokerage firms — for peer-to-peer transactions,” says David Malka, CEO of YieldFarming.com, which helps investors earn income from cryptocurrency. “These peer-to-peer transactions in DeFi can include everything from payments, investments, lending and more.”
In this world, cryptocurrency becomes the de facto currency for transactions and records.
“DeFi is the natural continuation of the vision outlined in the Bitcoin white paper of creating electronic cash, so it is a very exciting time in the industry,” Malka says.
Key benefits of DeFi
For individuals, the benefits of DeFi include potentially greater security, potentially lower costs, greater types of services and the ability to earn higher income through their crypto holdings. These benefits and others are enabled through decentralized apps created by various groups.
“Decentralized…
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