What Is DeFi? Understanding Decentralized Finance

Decentralized finance, also known as DeFi, uses cryptocurrency and blockchain technology to manage financial transactions. DeFi aims to democratize finance by replacing legacy, centralized institutions with peer-to-peer relationships that can provide a full spectrum of financial services, from everyday banking, loans and mortgages, to complicated contractual relationships and asset trading.

Centralized Finance Today

Today, almost every aspect of banking, lending and trading is managed by centralized systems, operated by governing bodies and gatekeepers. Regular consumers need to deal with a raft of financial middlemen to get access to everything from auto loans and mortgages to trading stocks and bonds.

In the U.S., regulatory bodies like the Federal Reserve and Securities and Exchange Commission (SEC) set the rules for the world of centralized financial institutions and brokerages, and Congress amends the rules over time.

As a result, there are few paths for consumers to access capital and financial services directly. They cannot bypass middlemen like banks, exchanges and lenders, who earn a percentage of every financial and banking transaction as profit. We all have to pay to play.

The New Way: Decentralized Finance

DeFi challenges this centralized financial system by disempowering middlemen and gatekeepers, and empowering everyday people via peer-to-peer exchanges.

“Decentralized finance is an unbundling of traditional finance,” says Rafael Cosman, CEO and co-founder of TrustToken. “DeFi takes the key elements of the work done by banks, exchanges and insurers today—like lending, borrowing and trading—and puts it in the hands of regular people.”

Here’s how that might play out. Today, you might put your savings in an online savings account and earn a 0.50% interest rate on your money. The bank then turns around and lends that money to another customer at 3% interest and pockets the 2.5% profit. With DeFi, people lend their savings directly to others, cutting out that 2.5% profit loss and earn the full 3% return on their money.

You might think, “Hey, I already do this when I send my friends money with PayPal, Venmo or CashApp.” But you don’t. You still have to have a debit card or bank account linked to those apps to send funds, so these peer-to-peer payments are still reliant on centralized financial middlemen to work.

DeFi Runs on Blockchain

Blockchain and cryptocurrency are the core technologies that enable decentralized finance.

When you make a transaction in your conventional checking account, it’s recorded in a private ledger—your banking transaction history—which is owned and managed by a large financial institution. Blockchain is a decentralized, distributed public ledger where financial transactions are recorded in computer code.

When…