What is Decentralized Finance (DeFi) in Crypto?

DeFi is one of the most booming trends in the crypto world. And that can hardly be surprising. A digital Wall Street, but without office towers and all those suits looking to get their share from you. That sounds too good, almost like a fairy tale, doesn’t it? Well, actually, such a system does exist, and it’s name is DeFi. Today, we will look at what DeFi represents and where you can find it!

What is DeFi? How is it different from CeFi?

DeFi stands for “Decentralized Finance,” and CeFi, in its turn, stands for “Centralized Finance.” In order to understand how DeFi works, it is important to clarify how CeFi works first. Financial institutions such as banks, insurance companies, and stock markets are all part of the centralized financial system, meaning there is someone in charge, be that one person or a group of people. Someone that is in control and makes the decisions. And just like in any other human-related business, centralized financial institutions can have mismanagement or be corrupted.
Imagine if you wanted to go to the bank and get a loan: you’ll have to talk to the bank clerk first, then go through never-ending credit history checks, then you will have to patiently wait, sometimes days and even weeks, until you get a response. There are too many variables, too much pressure, and too much depends on the people you do not know, but who have all the authority. DeFi, or decentralized finance, offers an alternative solution with no central authority whatsoever.
Its goal is to create a fair and transparent peer-to-peer financial system where everyone is in control of their funds. To do that, it fully relies on DApps, or decentralized applications. They operate just like any other app, with one major difference: DApps are supported by a peer-to-peer network and based on a blockchain platform. There is no defined owner, and once the DApp and its rules have been created and deployed, they become immutable. That is why DeFi is seen as the next step in financial evolution after the invention of bitcoin, which happened 11 years ago.
However, since we are talking about decentralization, there are no financial regulations like the ones we see in centralized financial systems. Of course, there are a lot of reliable DApps and contracts, but finding them and trusting them with your funds and personal data is always a matter of risk and fully lies on your own shoulders. That doesn’t mean that there is something wrong with DeFi. It just takes some time before the system evolves into something with more protection and reliability.

It is worth noting that most of the DeFi DApps are built on Ethereum blockchain. Certainly, there are other platforms like EOS,TRON, Solana but Ethereum is a recognized leader — for instance, one of the most popular and usable DEXs Uniswap is built on Ethereum platform.

DeFi in the crypto space

Truth is, DeFi is already a major part of the crypto ecosystem. And while it’s clear that DeFi is a giant leap forward for the whole crypto world with already more than $98 billion locked in contracts, the current state of it is still far from being perfect. The ecosystem struggles with hacks and mishaps, rug pulls and scams of different sorts.
However, even now, there are dozens of reliable dApps that have already proved their worth, and more will inevitably be developed in the near future. Just a quick look at the current crypto space will make it clear that DeFi services can be found literally anywhere: wallets, staking, DEX (decentralized crypto exchanges) and so on. The list can go further.
DeFi can be found in literally any part of the crypto world, and it would be a challenge to cover all of them, so let’s take a look at some of the most well-known representatives.

Wallets:

Owning a non-custodial crypto wallet is almost a necessity for every crypto trader and investor. They provide a safe and secure way of storing your digital assets, and unlike crypto exchanges, which also provide a similar service, the owner is the one who holds the private keys. Most well-known and commonly used wallets like Trust Wallet or MetaMask are utilized in the DeFi space.

DEX

Unlike centralized exchanges like Binance or Coinbase, decentralized exchanges like Uniswap, PancakeSwap, or Sushiswap allow traders and investors to buy and sell digital assets without a third party. These DeFi trading apps rely solely on blockchain technology and smart contracts, thus allowing investors to trade with each other directly without the need for a middleman.

Liquidity mining, yield farming and staking

Liquidity mining refers to pairing cryptocurrencies (both tokens or coins) the trader holds, and storing them in the liquidity pool. That allows, for example, DExes to have enough liquidity and liquidity miners to receive a reward for their investments.
Yield farming refers to earning interest on cryptocurrency, just like earning interest on fiat money in savings accounts. With yield farming, it takes an investor to lock his or her digital assets for a period of time in order to earn interest or other cryptocurrency. This process looks similar to “traditional” loaning usually used by banks, but instead of fiat money, you use your cryptocurrencies.
Staking stands for supporting a blockchain network by committing a trader’s crypto assets. Staking can be utilized with cryptocurrencies that use the proof-of-stake method, like the upcoming ETH 2.0 upgrade for the Ethereum network, and it allows investors to earn passive income.

Benefits and downsides of Decentralized Finance  

Some of the benefits and downsides have already been touched on in this article, so let’s take a closer look at what DeFi can offer and what it still lacks, at least for now.

So let’s start with the positive aspects of the DeFi:

Anonymity: When using DeFi services like DEX or wallets, you do not need to provide your personal information like your ID, email address, or even your real name.

Flexibility: Since there are no third parties involved, you can have access to your digital assets anytime you want and do everything you want with them without having to ask permission from the financial institution.

Transparency: With DefI being decentralized, you do not need to ask someone in charge for information regarding transactions, you can simply check them on your own.

Simplicity: The dapps in the DeFi space are designed to give their users a friendly, intuitive, and smooth experience. Since the number of DeFi projects tends to grow, everyone can find something for their own taste and needs.

Discrimination-free: You will not be discriminated against or censored as a result of using the dapps.Corporations and governments tend to block people from using their services for one reason or another, but within the DeFi space, that simply does not happen.

Certainly, nothing is ever completely bright, and even such a promising technology like DeFi has its downsides. Let’s take a closer look at them:

Not 100% secure: Certainly, nothing is ever safe and secure, and even a heavily guarded bank can be robbed. With the DeFi space, you can bump into scam projects, hijacked accounts, or technical issues that some of the dapps might have due to bugged code. So the golden rule of DYOR (Do Your Own Research) should definitely be followed when dealing with the DeFi ecosystem.

Fees: Since most of the dapps are built on the Ethereum network, you may encounter very high transaction fees due to the network’s conjunctions. Certainly, that issue does not apply to every blockchain, and some of the networks have very low fees. However, the more popular the network, the higher the “gas” price you have to pay for using it.

No regulation: Since there are no financial authorities to regulate DeFi space, traders and investors should keep track of their own records for tax purposes. And since the rules and laws vary from one country to another, you need to know these laws before you start trading. 

Uncertainty: The DeFi system is still young and has a long way to go, unlike the traditional financial system that’s been out there for decades already. That leads to uncertainty and concerns from the potential investors who still have not yet entered the world of crypto. And less investors means less value will be locked in the DeFi system’s liquidity. 

DeFi is booming. Will regulations follow?

SEC and US Treasury see crypto as the main rival to the traditional banking system. SEC Chairman Gary Gensler believes that DeFi space must be regulated for the sake of “investor protection”. Yes, you must’ve already understood that conventional financial institutions see the rise of the DeFi sector as a threat to them. So the main question is not whether DeFi will be regulated or not, but when the first regulations will follow. Certainly, there are some shady spots not only in the DeFi but in the crypto world in general: for instance, money laundering has become a serious concern for law enforcement agencies. However, in case the regulations aim at the anonymity and flexibility of the DeFi ecosystem, the whole point of it may vanish, since its basic idea is about being autonomous and decentralised with no one in charge.
It is still unclear what these regulations may look like and what will be the way of implementing them into the DeFi system, but it is unlikely that traditional financial institutions will leave it as it is now. 

Is there a future for DeFi?

DeFi at the moment has quite a few causes for concern. But at the same time, if you are willing to risk it, the reward can be very nice.
DeFi has made the transactions more secure and flexible than those in the CeFi space.
It is more liberalised and does not discriminate against you based on your geographical position or accessibility. You cannot be turned away by a bank clerk here. Everyone has equal opportunities. Anyone from anywhere in the world can join the system and start making money without the necessity of sharing the cut with middlemen.
It is safe to say that the DeFi system is by far the biggest and most important milestone in the financial world since the invention of the first cryptocurrency, bitcoin. Yes, it is still new and needs a lot of improvements to minimise the risks and make the potential benefits more accessible. This will be the main challenge the DeFi system has to overcome in the near future.
In any case, the prospects look bright and we can expect DeFi’s and dApps’ impact on our business and financial activities to become more and more significant in the upcoming years.
Decentralized finance technology has managed to change the face of financial services. Now anyone who codes can build his or her own business or even a whole financial empire. The question is how the DeFi will evolve and when this will occur.will find out soon enough.

FAQ

How is DeFi different from CeFi?

DeFi stands for “Decentralized Finance,” and CeFi, in its turn, stands for “Centralized Finance.”

What are benefits of DeFi?

Anonymity, Flexibility, Transparency, Simplicity