Blockchain technology has introduced an alternative to fiat currency with cryptocurrency such as Bitcoin. Worldwide adoption of crypto is still early, and many are unaware of the true potential cryptocurrency has through decentralized finance.

Personal finance is a common concern for everyone. Skepticism about centralized financial institutions is high, and we need alternatives to such an entrenched industry.

The blockchain will disrupt the traditional financial system through decentralized finance. Whatever your level of crypto experience, this article should help you, and people you know, better understand decentralized finance.

Intro to DeFi

Decentralized finance (“DeFi”) is an alternative to the traditional financial system. “Decentralized” simply means there is no central entity in control of a particular system. DeFi operates on the blockchain, which is accessible to anyone, at any time, from anywhere. There is no centralized figure in control of decentralized finance applications, and each individual has control over their assets.

DeFi is available to anyone who can use the internet. DeFi gives people who either do not have access or do not trust traditional financial services tools to transform their lives.

Decentralized applications are based on smart contracts, making transactions essentially peer-to-peer. Originally pioneered on the Ethereum blockchain, smart contracts are also available on BNB Chain, Polygon, Solana, and Cronos, among others.

Understanding DeFi

How does DeFi Work?

The backbone of decentralized finance is smart contracts. Smart contracts are code on the blockchain that runs when certain parameters are met. Smart contracts help automate transactions and remove intermediaries to make processes efficient and secure. Find out more about smart contracts here.

Smart contracts are the foundation of decentralized applications (“dApps”). Decentralized applications consist of multiple smart contracts deployed to the blockchain. The backend code is open source and forever on the blockchain, available for all to use.

DeFi protocols, through smart contracts and dApps, are able to replicate much of what is available in the traditional financial system. Individuals have much greater access to markets around the world.

There are varying degrees of decentralization. The original developer sometimes retains control; often, control is passed to the community through governance tokens. Governance tokens give voting rights to holders to decide on the direction of the DeFi application.

The traditional finance industry has well established infrastructure. This can make it hard to react and innovate in the financial space. Decentralized finance makes it much easier to develop new ideas and get them in front of people. This gives people the chance to take advantage of new things.

Competition and efficiency help all of finance, both traditional and decentralized, work to benefit all people across the world.

DeFi vs TradFi

“Finance” is simply the efficient allocation of capital. There are many similarities between decentralized and traditional finance in that they both involve people putting their money to use. However, there are notable differences in implementation.

• Decentralized finance is available to anyone with internet while traditional finance is available to those who pass an approval process and have access to a branch or broker
• In DeFi, individuals have possession and control of their assets instead of interfacing with an institution which retains control
• DeFi transactions happen automatically rather than requiring manual paperwork and added processing time
• Individuals can make DeFi transactions at any time instead of waiting for normal business hours in the area they are transacting

Ultimately, the difference between the two systems is the removal of a central entity in financial transactions. Smart contracts automate the process and improve efficiency without the need to wait for a third party.

What can you do with DeFi?

Decentralized finance can replicate many aspects of the traditional financial system. Only the creativity of the developers pushing the space forward limits its potential. Decentralized finance companies continue to find new ways to apply DeFi and smart contracts. Some current uses of DeFi include:

Lending/Borrowing

Decentralized banking gives Individuals access to lending and borrowing with transparent interest rates, calculated automatically based on supply and demand.

After making a deposit, the protocol issues a token that acts as a receipt. These tokens automatically collect interest as it is earned. Funds can be withdrawn at any time from most pools but other pools require a minimum lock up period. Hunting for the best available rates is known as yield farming.

Users can also borrow using cryptocurrency or NFTs as collateral. They no longer need to sell their assets to have its spending power. Access to a global market means rates are more competitive and more people have access to loans when they need them.

Investing

The decentralized finance system redefines “investing.”

Users no longer have to pore over various index funds and equities in building their portfolio. Rather, people can search for projects whose mission, vision, and values are in alignment with their own personal ideals. Critically, if DeFi participants want a long term growth thesis, they should evaluate projects based not upon short-term price pumps, but on commitments to longevity.

Once a DeFi participant is confident in their thesis, they can purchase project tokens with the “native coin” of the blockchain (for example, Ethereum) through a decentralized exchange. A decentralized exchange, or “DEX”, allows users to exchange one cryptocurrency asset for another. DEXs work differently than centralized exchanges, because they do not use an “order book” model. Trades and prices are governed by a liquidity pool which automatically processes transactions instead of matching buy and sell orders.

Anyone can add liquidity on a DEX to enable trading for their project token. Liquidity providers are compensating by receiving a share of trading fees. Combining two assets together into a liquidity token on the exchange creates trading pairs.

However, there are risks. DeFi is still early, and many projects are highly speculative. As ever, participants in the DeFi space must commit to doing their own research.

Stable Coins

Stable coins allow users to bypass the volatility in crypto prices. These coins or tokens are pegged to a fiat currency which allows interaction with dApps with a steady value. This allows users the ability to spend cryptocurrency while holding onto their current assets if they anticipate future price appreciation.

Fundraising

Individuals can use cryptocurrency for fundraising, similar to Kickstarter or GoFundMe. Anyone across the globe can contribute to crowdfunding efforts. Since the process takes place on the blockchain, there is transparency with where the funds ultimately end up. Also, the smart contracts can be coded to automatically refund the contributions if the funding goals are not met.

Crypto fundraising has become increasingly popular with more and more charities allowing cryptocurrency donations.

What are some concerns about DeFi?

There are things to be aware of for people getting involved in DeFi. Decentralized finance empowers people to make financial decisions for themselves, but it is important to be an informed participant.

Since there is no central authority in DeFi, each individual has responsibility for their actions. They must understand what they are agreeing to and the risks associated with the decisions they make. The smart contracts can only perform the actions they have been coded to perform.

Crypto markets are volatile. Everyone needs to be comfortable with price fluctuations and how the fluctuations may affect each DeFi project they interact with.

It is also important to understand that regulations differ from jurisdiction to jurisdiction. Regulations that affect one person may not affect another. It is each individual's responsibility to comply on their own without a central authority generating the necessary forms for them.

Getting Started in DeFi

There will always be more to learn about DeFi as the space is advancing every day. Research the different blockchains available and find a project developing a product you are interested in.

EverRise is working to make DeFi a safer space by building tools to help secure projects. Be sure to sign up for our newsletter for our latest articles about DeFi topics and check out our daily Twitter Spaces.