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What is Decentralized Finance?

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What is Decentralized Finance

Decentralized finance—often called DeFi—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain. From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments. Now with over $13 billion worth of value locked in Ethereum smart contracts, decentralized finance has emerged as the most active sector in the blockchain space, with a wide range of use cases for individuals, developers, and institutions. In this blog post, we will explore what decentralized finance is, how it works, and some of its key applications.

What is Decentralized Finance?

DeFi Developers defines decentralized finance as a rapidly growing ecosystem of financial protocols built on Ethereum that enables anyone, anywhere to access digital asset-backed financial services. With DeFi, there is no need for a central authority or middleman to provide financial services – instead, they are delivered peer-to-peer on the Ethereum blockchain. This not only makes DeFi services more accessible and affordable, but also more secure and resilient, as they are powered by smart contracts that run exactly as programmed without any possibility of fraud or third party interference.

The range of DeFi protocols and applications is constantly expanding, but some of the most popular include MakerDAO (which issues the stablecoin Dai), Synthetix (a synthetic asset platform), Compound (a money market protocol), and 0x (a decentralized exchange protocol).

By using Ethereum’s decentralized infrastructure, DeFi protocols can offer a wide variety of financial services that were previously only available through centralized institutions such as banks, brokerages, and exchanges. These include lending and borrowing platforms, stablecoins, tokenized BTC and ETH assets, synthetic assets, decentralized exchanges, and much more.

The explosive growth of the DeFi ecosystem in 2020 has been driven by a number of factors, including the launch of new protocols and applications, an increase in users and transaction volume, and a surge in interest from both retail and institutional investors. With over $13 billion worth of value locked in

How Does Decentralized Finance Work?

Decentralized finance—often called “DeFi”—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain.

From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments. Now with over $13 billion worth of value locked in Ethereum smart contracts, decentralized finance has emerged as the most active sector in the blockchain space, with a wide range of use cases for individuals, developers, and institutions.

So how does decentralized finance work? In this guide, we’ll explore the key components of DeFi and how they interact to create a new paradigm for financial applications.

At its core, decentralized finance is about using crypto assets and smart contracts to build financial protocols and platforms that run on the Ethereum blockchain. By deploying immutable code on a public, permission-less network, DeFi developers can launch financial applications that run exactly as programmed and that are available to anyone with an Internet connection.

The breakthrough of DeFi is that crypto assets can now be put to use in ways not possible with fiat or “real world” assets. Decentralized exchanges, synthetic assets, and flash loans are completely novel applications that can only exist on blockchains. This opens up a world of possibilities for how we interact with our finances on a day-to-day basis.

The Benefits of Decentralized Finance

Decentralized finance—often called “DeFi”—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain. From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments. By deploying immutable smart contracts on Ethereum, DeFi developers can launch platforms and products that run exactly as programmed and that are available to anyone with an Internet connection.

The breakthrough of DeFi is that crypto assets can now be put to use in ways not possible with fiat or “real world” assets. Decentralized exchanges, synthetic assets, and flash loans are completely novel applications that can only exist on blockchains. This paradigm shift in financial infrastructure presents a number of advantages with regard to risk, trust, opportunity, and inclusion.

From DAOs to synthetic assets, decentralized finance protocols have unlocked a world of new economic activity and opportunity for users across the globe. The comprehensive list of advantages below outlines why DeFi just might be the most important thing to happen in crypto since Bitcoin.

Asset Ownership: In traditional finance, third parties such as banks or brokerages control our financial assets. With DeFi applications built on Ethereum, however, you are always in control of your own crypto funds. Crypto wallets like MetaMask or Gnosis Safe enable you to easily access decentralized applications (DApps

The Risks of Decentralized Finance

Decentralized finance—often called “DeFi”—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain. From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments. Now with over $13 billion worth of value locked in Ethereum smart contracts, decentralized finance has emerged as the most active sector in the blockchain space, with a wide range of use cases for individuals, developers, and institutions.

Despite its rapid growth and increasing popularity, there are still significant risks associated with participating in the DeFi ecosystem. Below we outline some of the key risks to be aware of before getting started with DeFi.

Counterparty Risk:
When engaging in any type of financial transaction, there is always counterparty risk—the risk that the other party will not fulfill their side of the deal. In traditional finance, this risk is mitigated by central intermediaries like banks or credit agencies that act as trusted third parties. However, in decentralized finance protocols there is no central authority to guarantee that transactions will be executed as agreed upon. As such, it’s important to carefully vet any platform or project before transacting, and to only deal with counterparties that have a good reputation within the community.

Smart Contract Risk:
All decentralized applications (dApps) are built on smart contracts.

What are some examples of Decentralized Finance?

Decentralized finance—often called “DeFi”—refers to the shift from traditional, centralized financial systems to peer-to-peer finance enabled by decentralized technologies built on the Ethereum blockchain. From lending and borrowing platforms to stablecoins and tokenized BTC, the DeFi ecosystem has launched an expansive network of integrated protocols and financial instruments. Now with over $13 billion worth of value locked in Ethereum smart contracts, decentralized finance has emerged as the most active sector in the blockchain space, with a wide range of use cases for individuals, developers, and institutions.

Here are some examples of Decentralized Finance: 

  • MakerDAO is a decentralized autonomous organization that provides Dai, the world’s first decentralized stablecoin on the Ethereum blockchain. Dai is pegged to the US Dollar and collateralized by ETH, creating a more stable cryptocurrency that can be used in everyday transactions. 
  • Compound is an open-source protocol that allows users to earn interest on their crypto assets or borrow assets at an interest rate set by the market. By connecting lenders and borrowers directly, Compound removes the need for intermediaries and allows users to trade directly with each other. 
  • Synthetix is a synthetic asset platform that enables users to trade digital assets that track real-world commodities like gold, silver, oil, and foreign currency. 

How can I get involved in Decentralized Finance?

There are a few ways to get involved in Decentralized Finance (DeFi). The first is to simply use the services that exist on the Ethereum blockchain. The second is to develop or contribute to existing projects. The third is to create new projects or protocols.

If you want to use DeFi services, there are a number of ways to do so. You can use a decentralized exchange (DEX) such as Uniswap or 0x Protocol to trade tokens. You can also take out loans from lending platforms such as MakerDAO or Compound. Or, you can use stablecoins such as Dai or USDT to store value in a cryptocurrency that is pegged to the US dollar.

If you want to develop or contribute to existing projects, there are many ways to do so. You can join an existing team, such as the MakerDAO core team or the 0x Protocol development team. Or, you can start your own project and build it from scratch. There are also numerous open-source projects that anyone can contribute to, such as MetaMask and Gnosis Safe.

Finally, if you want to create new projects or protocols, you can do so by using the Ethereum blockchain and its smart contract functionality. You can also build on top of existing protocols, such as 0x Protocol or MakerDAO, by creating new applications or integrations.

 

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