Decentralized finance (or "DeFi") is a financial ecosystem based on blockchain technology. It lets users buy and sell assets and financial services as a form of investment or financing without middlemen.
How does DeFi work?
To understand how DeFi works, we must first delve into what’s behind it. DeFi uses blockchain, which connects users without a central server and can transfer data and assets securely, under the users' own watch. Transactions are regulated under "smart contracts", computer programs that also use blockchain and run automatically when the parameters the parties set in advance are met.
They use blockchain to store and transfer digital assets and smart contracts to make sure the parties keep their end of the bargain.
What's DeFI for?
A recent phenomenon, DeFI's potential and use will largely depend on user needs and regulation. People and businesses invest and get funding with DeFi apps that bridge supply and demand, using blockchain to make sure transactions remain secure.
What do you need to use DeFi?
Since DeFi apps have an open code, anyone with Internet can use it, create and offer services (like lending), and combine existing services. DeFi software and systems are available to the public free of charge and can even be copied, enhanced or adapted to user needs.
DeFi app users looking for a return on investment in tokens can program a smart contract to sell cryptocurrency at a certain price. And users who want to buy tokens can prepare a smart contract to automatically acquire them when they reach the desired value. In both cases, transactions are automatic and there’s no middleman.
Things to bear in mind
As a decentralized financial ecosystem, it’s not regulated. Under the traditional financial system, personal details can be checked to review loan applicants' indebtedness and other aspects. In blockchain, however, a public key that holds no personal information is the "identifier". This can make preventing fraud and other financial crimes tricky.
Security is also an important factor. On DeFi platforms, users safeguard their own assets via access keys and authentication to sign in to apps. Because no entity can provide or restate their personal details if they're stolen, users could lose all their assets.