Introduction to Decentralized Finance

Beginner
March 29, 2023
Read time:
6m

Imagine a future in which governments and banks no longer have unlimited control over your finances. Instead, you can trade with anyone you wish without the need for an intermediary. This is no longer just a dream. Welcome to the world of Decentralized Finance (DeFi).


DeFi is an open, decentralized, and global financial system that allows for secure, fast peer-to-peer transactions without the involvement of third parties, such as banks or other financial institutions. You may wonder, what does "decentralized" really mean? What are peer-to-peer transactions?


Decentralization of finances means transferring control from a centralized entity, such as financial organizations, to a distributed network in which all members have similar levels of authority, and every transaction is executed in a transparent, secure manner. Centralized institutions are prone to systemic failures or corruption when certain actors gain more control than is necessary. In decentralized finances, such abuse of power is impossible, as the distribution of resources is transparent and fair.


A peer-to-peer transaction is a direct exchange of assets between two parties without any central authority, such as a bank. In this way, the need for a "middleman" is eliminated, along with hefty brokerage fees


Main benefits of DeFi architecture

DeFi is gaining popularity in many parts of the world because of the following:

  • Enhanced accessibility – Low-income individuals benefit from access due to reduced operating expenses and equitable access regulations.
  • Full transparency – all transactions are public on blockchain;
  • Low fees  – without a 'middle man' transactional fees are minimal;
  • Security – all transactions are secure, and users can enjoy full anonymity as their data is not disclosed;
  • Low risk of system failure – data is distributed via thousands of blockchain nodes, so there is no single point of failure.

Decentralized applications (dApps)

You can't discuss DeFi without mentioning dApps. Decentralized applications, called dApps are digital applications that run on a peer-to-peer blockchain network, rather than centralized servers. They are built for various reasons, such as finance, gaming, medicine, education, file storage or even social media.


However, that's not the only thing you should know about these applications. They are often built on the Ethereum blockchain and stored on a blockchain system, where their execution also occurs. Validation is carried out by cryptographic tokens, which are necessary to access dApps. Due to their ability to simplify processes, dApps are significant in transaction processing. With dApps, sending money is instant and there are minimal costs, such as gas fees.

Over the years, dApps have become a significant part of the blockchain space due to their flexibility and independence from a single authority. An example of a dApp is Pancake Swap, which uses the Binance Smart Chain to allow the swapping of BEP-20 tokens, as well as AAVE, one of the most popular DeFi-based open-source liquidity protocols.

DeFi vs. CeFi

Cross-chain services

CeFi supports trading of many tokens issued on independent blockchain platforms, while DeFi does not. This is a significant benefit for CeFi since many of the biggest and frequently traded cryptocurrencies exist on such blockchains and do not implement cross-chain standards.


Intermediary

The first fundamental difference between CeFi and DeFi is the presence of an intermediary in CeFi and its absence in DeFi. This topic has already been discussed, so we will not elaborate further.


Anonymity

Most DeFi projects are handled by unidentified groups and do not require any KYC procedures.


In contrast, CeFi operates differently, where the user typically must undergo KYC, and central exchanges handle trades. This also means the user does not own a private key providing access to their wallet.

Custody

DeFi provides its users with complete control of their funds and assets. However, this may result in a higher risk of all technological hazards. In this case, CeFi may be more beneficial since it takes on the responsibility of ensuring the safety of its users' funds.


Security

Although centralized finance (CeFi) strives to ensure optimal security, numerous breaches have occurred on CeFi-based cryptocurrency exchange platforms. In contrast, when it comes to decentralized finance (DeFi), users need only be vigilant about the code and consensus algorithm employed in the respective DeFi projects.


Summary

Decentralized Finance (DeFi) is an open, global system that enables peer-to-peer transactions without the involvement of a third party.


Decentralization transfers control and authority from centralized entities to a distributed network, making abuse of power nearly impossible. DeFi transactions are faster, cheaper, and safer than traditional bank transactions because they operate 24/7, do not require third-party assistance, and users do not need to disclose personal information.


Traditional finance leaves many under-banked or unbanked individuals prone to cyberattacks and has lower efficiency due to limited operating hours. High accessibility, low fees, full transparency, and high security are the main benefits of DeFi.

Complete quiz
Introduction to Decentralized Finance
Share this article
Explore other articles
Intermediate

Atomic Swaps

The atomic swap process is a safe and direct way to exchange assets in the cryptocurrency market. By using smart contacts, transactions are secured and do not require the involvement of an intermediary.
Beginner

How to safely purchase cryptocurrencies?

Crypto security should be your top priority if you are a crypto trader. Lack of transparency and scarce information on technology and security measures are red flags if you are looking for a reliable crypto exchange.
Advanced

Exponential Moving Average (EMA) and Simple Moving Average (SMA)

Exponential Moving Average and Simple Moving Average are two technical indicators used in financial analysis. While SMA calculates the average price over a specific time by taking the arithmetic mean of the closing prices, EMA places more weight on recent prices.