DeFi stands for decentralized finance. The key term here is decentralized. The modern financial world is all centralized. There is a controlling authority that decides who gets access to bank accounts, insurance, loans, and other financial products. DeFi is supposed to change all that by making everything decentralized.

The vision behind decentralization of finance is to allow anyone to do their banking such as borrowing money, lending money, buying insurance, trading assets, trading derivatives, buying insurance, and a lot more things without the reliance on a decentralized party or paperwork. The proponents of the system argue that decentralized finance is about creating a digital alternative to traditional financial markets but without its associated costs.

At the core of DeFi is the blockchain technology that came into existence in 2009 with the advent of bitcoin. There are many crypto projects but two of the most popular are Bitcoin and Ethereum. While various crypto projects can be used for decentralized finance, most of the projects are built on Ethereum due to certain inherent advantages.

One of the main reasons for Ethereum being the main blockchain for most decentralized finance projects is the inclusion of smart contracts in the blockchain. The use of smart contracts as part of the blockchain allows trustless transactions without third-party interference.

Advantages of Decentralized Finance

One of its biggest advantages is its decentralized nature. You don’t need to meet pre-existing criteria to become a part of this new ecosystem. You just need a crypto wallet and a few crypto coins to get started. Also, it protects your privacy to a large extent as you are not required to disclose any personal information to participate.

Another big advantage of DeFi is that it is much faster as compared to traditional banking. In traditional banking, everything takes days or weeks - be it getting loans or getting paid interest or other such things. On the other hand, everything works in seconds in the DeFi ecosystem. And everything is transparent as everything is part of the blockchain.

How It Works

To become a part of the decentralized finance ecosystem, you need a crypto wallet, crypto assets, and a decentralized app. There are all kinds of decentralized apps. For example, there are lending and borrowing apps that work similarly to traditional banks.

The only difference here is that the process is completely decentralized which means there is no intermediary. Borrowers can borrow money by using their existing crypto assets as collateral. Similarly, anyone can lend crypto and earn interest.

There are also decentralized apps for trading cryptocurrencies anonymously. There is also a yield farm. In a yield farm, anybody with a wallet and some crypto can invest a part or all of their digital assets to generate passive yield. Yield farms are one of the most popular decentralized finance applications.

Limitations of Decentralized Finance

There are advantages of DeFi, but there are also some limitations. One of the biggest limitations is the fluctuating transaction rates. Crypto is highly volatile and you never know how much your crypto assets are going to be worth in the near future. Also, decentralized finance means keeping records of all the transactions for tax purposes is on you. There is no bank statement or any other thing you're going to get from somewhere to make it easy for you to calculate taxes.

Another major limitation of decentralized finance is that it is an open field for everyone. Scams are not a new thing in the crypto industry and decentralized finance isn't virgin territory for scammers. Having said that, you shouldn't have any problem participating in DeFi ecosystem by downloading apps that are known to be reliable and safe.

Final Thoughts

Think of decentralized finance as an umbrella term for all the financial services that are blockchain-based and operate in the crypto world. The space is new and a lot of exciting things are happening. Many experts think that DeFi is going to have a huge impact on the way banking works.

It allows you relative anonymity while maintaining transparency as all the transactions are part of the blockchain. If you would look like to become part of the DeFi space, the only things you need are a reliable crypto wallet, some crypto assets, and a decentralized finance app for whatever you want to do.