The ultimate guide to DEFI (Decentralised Finance)

Defi is shorthand for “decentralized finance.” This is a generic, all-encompassing term for an ecosystem of financial products and services built on top of blockchain networks. The idea is to allow anyone with internet access to lend, borrow and bank without going through a “middleman” or central authority. Defi is increasingly popular and currently one of the fastest-growing areas in the cryptocurrency marketplace. Let’s look at some use cases of Defi.

What’s so good about Defi?

Want to take out a loan or lend someone money in return for interest? You don’t need the bank to help you. You can get a loan directly from your peers or lend directly to them. This makes the loan cheaper as no middleman is taking a fee.

Ready to bet on Bitcoin futures and other derivatives? Forget finding a bookie. You can do this using automated software on the Blockchain, which is also much cheaper than using an institutional middleman. Looking to swap one asset for another? Decentralised exchanges can facilitate the transaction without taking a huge cut.

Defi has several other attractive features.

Accessibility

It is much more accessible to the average investor than banking services are. Services can often be accessed without providing any identifying information, such as name and address. It therefore, provides access to financial products such as loans to those who would otherwise be isolated from the current financial system due to a lack of the required documentation.

Furthermore, the infrastructure upon which the traditional financial system is built on (such as buildings, banks etc.) is often absent from locations with low-income communities, which can be very remote. However, with Defi, this infrastructure is not necessary. All that is required to use these services is an internet-connected device. Therefore low-income individuals in remote areas can also benefit from a broader range of financial services.

Speed and Affordability

Users can move funds around near-instantaneously via a blockchain, so there is no waiting for the bank transfer to clear, which often takes several days.

Another great benefit is that the transaction fees (for now, at least) are much better than at traditional banks. This is because these services are offered peer to peer and through automated software. Therefore there are little to no costs to pay for the services of a middleman, and no requirement for bankers or financial workers to process the transactions.

Convenience and Security

Defi services are available 24 hours a day, seven days a week. No need to wait for banks or financial services providers to open and operate during regular business hours of the week.

Defi also offers better security than traditional finance. Most of the existing and potential applications of Decentralized Finance involve creating and executing smart contracts. While a usual contract uses legal terminology to specify the terms of the relationship between the entities entering the contract, a smart contract uses computer code.

Since their terms are written in computer code, smart contracts have the unique ability also to enforce those terms through computer code. This enables the reliable execution and automation of many business processes that currently require manual supervision. And these transactions are recorded on the blockchain, which is considerably harder to edit and manipulate than the financial records of a traditional financial institution like a bank. Using smart contracts is faster, easier, and reduces the risk for both parties.

How did Defi start?

Well, there is no single inventor of Defi. However, Defi applications first appeared on top of Ethereum, invented by a brilliant Canadian Russian teenager named Vitalik Buterin at 19 years of age. It has since expanded to other networks that use smart contracts to automate transactions. These include Solana, Binance Smart Chain, and Avalanche.

Disadvantages

Despite all of its advantages, there are some disadvantages related to Defi. Let’s examine a few of the most significant drawbacks.

Low Liquidity

One disadvantage of Defi is that liquidity levels in Defi based projects tend to be lower than is the case in traditional financial institutions. For the most part, this is not a significant issue. However, for some DEFI projects will have liquidity levels that are so low that they cannot deliver some of their services efficiently. For example, some consequences of users investing in a project with very low liquidity levels may include buying and selling orders taking a very long time to fulfil.

Complexity and tech-related Issues

The Defi space can be complex to navigate, and it requires a high level of financial literacy competence, which is not necessarily the case with traditional finance. This is because with traditional financial institutions there are well trained and regulated experts working in this field. These experts are qualified to educate, advise and guide financially illiterate clients to the best financial product to suit their needs. With Defi, however, there is far less support of this nature.

Furthermore, as everything is recorded with computer code, there is some risk that the code used may have bugs and vulnerabilities.

Future prospects of Defi

Despite the issues mentioned above, from a neutral perspective, the future of Defi looks great as the pros of Defi outweigh the cons. The evidence for this is clear from the vast increase of US dollars invested in Defi worldwide over the last two years alone. There was 680 million USD invested in Defi worldwide in December 2019, which has increased dramatically to over 80 billion dollars in 2021. This is due to increased retail investment and growing interest and investment by institutional investors. Furthermore, there is a growing range of new and innovative Defi products regularly entering the market, which is a trend that continues to this day.

Get access to all of our exclusive content.