You've probably heard of decentralized finance. Over the last few years the technology has gained significant popularity and presents clear opportunities for innovation in the future. However, how does decentralized finance work? Here we explain the ins and outs of DeFi.

What is decentralized finance?

In order to understand decentralized finance, it is first important to understand what decentralized means. A decentralized system is one that is not centrally controlled but instead distributed among a network of nodes. This decentralized network can be contrasted with a centralized system, which would have a central authority that controls all aspects of the system.

Decentralized finance, often called DeFi, refers to the shift from traditional, centralized financial systems to decentralized ones built on blockchain. This new wave of financial applications are powered by smart contracts, which are essentially self-executing code that runs on the blockchain networks.

Because DeFi applications are built on blockchain technology, they are open source and transparent. This means that anyone can audit the code to check for bugs or vulnerabilities. Moreover, because decentralized applications are decentralized, they are not subject to the same regulations as traditional financial institutions.

How does decentralized finance work?

Decentralized finance works by using smart contracts to connect decentralized applications, or dapps, to blockchain technology. These dapps can be used for a variety of purposes ranging from lending and borrowing platforms to decentralized exchanges.

DeFi is secured  by a decentralized infrastructure, which means that it is not subject to the control of any single entity. This decentralized infrastructure also makes DeFi applications censorship resistant.

Because DeFi applications are built on blockchain, they can take advantage of native tokens, such as ether (ETH). Ether is used to pay for transaction fees and gas, which is the fee charged for executing a smart contract on the Ethereum network.

When dealing with DeFi, all transactions are done virtually. This means  that there is no need for a bank or other third-party intermediary. Instead, transactions are peer-to-peer, which makes them cheaper and faster.

Users keep their funds in  a decentralized wallet, such as MetaMask or Gnosis Safe. Wallets are protected with private keys, which are completely unique and are the only way to access the contents of the wallet. 

What are the benefits of decentralized finance?

There are several benefits of decentralized finance. 

Transparency

One of the main benefits of the DeFi system is that  it is transparent. Because decentralized applications are built on the Ethereum blockchain, all transactions are public and can be seen by anyone. 

This transparency ensures that there is no room for fraud or corruption. Moreover, it makes it easy to track where your money is going and how it is being used. 

Censorship resistance

Another benefit of decentralized finance is that it is censorship resistant. This means that no single entity can control or censor the network. 

Because decentralized applications are decentralized, they are not subject to the same regulations as traditional financial institutions. 

This provides a great deal of freedom for users and developers alike. 

Lower costs

DeFi also has the potential to lower costs for users. Because there is no need for a bank or other third-party intermediary, DeFi can be cheaper and faster. 

In addition, decentralized exchanges do not charge listing fees, which can save users a great deal of money. SokuSwap is a great example of a DEX that charges low fees so that traders can make the best possible profits from their strategies. 

What are the use cases for decentralized finance?

Decentralized finance can be used for a variety of purposes. One popular use case is lending and borrowing platforms. These platforms allow users to lend or borrow digital assets without the need for a bank or other third-party intermediary. Another popular use case is decentralized exchanges. These exchanges allow users to trade digital assets without the need for a centralized exchange. Finally, decentralized finance can also be used for hedging and insurance purposes.

How to use DeFi in day-to-day life

There are a number of ways to use decentralized finance in day-to-day life. One way is to use a decentralized exchange to trade digital assets. Another way is to use a decentralized lending platform to borrow or lend digital assets. Finally, you can also use decentralized finance for hedging and insurance purposes. 

Using DeFi regularly is a good way to prepare for the mass adoption of cryptocurrencies that is set to take place in the foreseeable future. Some countries have started accepting crypto as a legal tender, which is a clear indication that the world is moving towards decentralized finance.

Frequently asked questions

How do you make money with DeFi?

There are a few ways to make money with decentralized finance. One way is to provide liquidity to a decentralized exchange. This involves depositing digital assets into a decentralized exchange and then earning interest on the deposited assets. Another way to make money with DeFi is to provide liquidity to a decentralized lending platform. This involves depositing digital assets into a decentralized lending platform and then earning interest on the deposited assets. Finally, you can also earn fees by providing hedging and insurance services on a decentralized finance platform. 

What is the difference between DeFi and CeFi?

The main difference between decentralized finance and centralized finance is that decentralized finance is built on the Ethereum blockchain, while centralized finance is not. Because of this, decentralized finance is transparent, censorship-resistant, and decentralized. Centralized finance, on the other hand, is not transparent, is subject to censorship, and is centralized.

What is DeFi in simple terms?

Decentralized finance, or DeFi, is a financial system that is built on blockchain technology. DeFi is transparent, censorship-resistant, and decentralized. Because of this, it has the potential to provide a great deal of financial freedom to users.

Is DeFi safe?

DeFi is decentralized, which means that it is not subject to the same regulations as traditional financial systems. This provides a great deal of freedom for users, but it also comes with some risks. It is important to carefully research any DeFi platform before using it. In addition, users should always store their digital assets in a secure wallet.

Posted 
Jun 28, 2022
 in 
DeFi Education
 category

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