A beginner’s guide to decentralized finance (DeFi) 

With its centralized infrastructure and intermediaries, the traditional financial system has long been the dominant force in global finance. A new paradigm is emerging that challenges this conventional model of decentralized finance, or ‘DeFi’ for short. DeFi offers a peer-to-peer financial services alternative built on blockchain technology. It reduces the middleman and increases accessibility, transparency, and equality. With DeFi, you borrow, lend, earn interest, trade, and even insure against risks without traditional banks or financial institutions.

With blockchain technology, DeFi platforms and applications are secure, transparent, and tamper-proof. Smart contracts, which are self-executing contracts that automatically enforce the terms of an agreement, are a vital component of DeFi. These smart contracts enable trustless interactions between peers, ensuring that once predetermined conditions are met, the contract executes as programmed without third-party involvement.

DeFi encompasses various financial services, including lending and borrowing, decentralized exchanges, stablecoins, insurance, asset management, and more. The critical difference between traditional finance and DeFi is the absence of central authorities or intermediaries, which results in greater user control, improved accessibility, and enhanced privacy and security.

How does DeFi work?

DeFi platforms and applications are typically built on public blockchains, with Ethereum currently being the most popular choice because of its smart contract functionality and extensive developer community. These open-source, decentralized applications (dApps) boost transparency and trust. To use DeFi services, individuals connect to these dApps via a Web3-enabled wallet, such as MetaMask, which allows them to interact directly with the blockchain and the dApp. Using this wallet, they can manage their assets, control their funds, and interact with various DeFi protocols.

Once connected, users access various financial services, often with just a few clicks. For example, they lend their crypto assets to a lending protocol and earn interest or borrow against their crypto holdings to gain access to liquidity. They also trade tokens on decentralized exchanges, invest in asset management funds, or purchase insurance policies to protect their crypto assets.

Why does DeFi matter?

With DeFi, traditional finance could be transformed into an open, inclusive, transparent alternative. Here are some of the critical reasons why DeFi is gaining traction:

• Accessibility – With DeFi, anyone with an internet connection and a crypto wallet can access financial services, regardless of location or background. This primarily benefits the unbanked or underbanked, who may lack access to institutions for socio-economic reasons.
• Transparency and trust – DeFi platforms are built on public blockchains, meaning all transactions and data are recorded on a transparent, tamper-proof ledger. This gives users greater visibility and assurance as they verify the system’s integrity and other participants’ actions.
• Interoperability – DeFi protocols are often interoperable, allowing seamless interactions between platforms and services. Using a single wallet, users can access more financial products and services.
• User control and privacy – In DeFi, users always maintain full custody and control of their assets. Unlike traditional finance, where users must trust intermediaries with their funds, DeFi puts the power back in the hands of the individual, improving privacy and reducing counterparty risks.

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