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What is DeFi?

An explainer on decentralized finance and its use cases.

lalav
lalavJan 10, 2023
What is DeFi?

DeFi is short for Decentralized Finance, which is an umbrella term for a new financial system built on open networks. This financial system allows direct interaction between parties without any intermediaries—which means you pay someone without going through middlemen like banks. Bitcoin in many ways was the first DeFi application.

Why does DeFi matter?

DeFi is an attractive alternative to conventional finance because of three key characteristics: It is open, decentralized, and enables the development of other decentralized apps.

1. DeFi is a Decentralized Financial System

DeFi is a decentralized financial system that allows people to connect directly with each other. The idea behind DeFi is that there are no intermediaries between you and whoever you’re trying to interact with (like an exchange). You can use this technology anywhere in the world and still have access to funds from all over the world without having any bank accounts or other forms of identification required. This makes DeFi incredibly useful for hedging risk by allowing users who want more exposure in certain markets but don’t want their funds stuck on centralized exchanges.

2. DeFi has Open Networks

Openness means that anyone can participate in DeFi without requiring permission from anyone else, meaning no centralized services required! It uses open source software and protocols. This makes it easy for developers to create their own applications on top of the base infrastructure like Ethereum, Bitcoin etc. Although building such applications can be difficult and time consuming, Blockchain infrastructure providers like Bitpowr help you simplify the process find out more here.

3. DeFi Builds on Existing Blockchain Infrastructure

DeFi is built on existing blockchain infrastructure. The most important part of a blockchain is its ability to maintain consensus across all users, which means that everyone agrees as soon as they join the network. This makes it possible for any user to submit data or make an action without needing permission from others—and it also means that when you’re using the system, you don’t have “ownership” of your assets (like cryptocurrency) because other people are also using them at the same time!

Lastly, we build on top of existing technologies like Ethereum so that as our ecosystem grows, we don’t introduce security risks such as hacks or downtimes which could otherwise happen if everything was built anew from scratch each time.

Major DeFi Use cases

1. Tokenization

Tokenized assets are typically tokens that represent real-world assets such as stocks or bonds. For example, a company might issue its own cryptocurrency in order to raise funds for a new venture. These cryptocurrencies can be traded like any other asset—they’re just based on something else! One of the benefits of using this method is that it allows companies to issue their own digital currencies without having to go through intermediaries like banks or brokers (which means there’s less risk). This makes it easier for them to get funding from investors who might otherwise have trouble accessing traditional financing options because they don’t have any experience dealing with these types of investments before."

2. Asset Management

With DeFi protocols, you are the custodian of your own crypto funds. Crypto wallets and institutional-grade custody providers like Bitpowr help you easily and securely interact with decentralized applications to do everything from managing, buying, selling, and transferring crypto to earning interest on your digital assets.

3. Data and Analytics

DeFi protocols provide distinct advantages for data discovery, analysis, and decision-making around financial opportunities and risk management due to their extraordinary transparency. DeFi Pulse, for instance, is one of such tools, it helps users to monitor the value locked in DeFi protocols, evaluate platform risk, and contrast yield and liquidity. This growth in new DeFi apps has been incredibly rapid.

4. Compliance and KYT

In traditional finance, anti-money laundering (AML) is based on know-your-customer (KYC) guidelines. In the DeFi space, compliance is based on participant behavior rather than participant identity. These know-your-transaction (KYT) services, such as Bitpowr’s, help in real-time risk assessment and protect against fraud and financial crimes.

5. DAOs

A DAO is a decentralized autonomous organization that operates according to transparent rules encoded on the Ethereum blockchain, eliminating the need for a centralized, administrative entity. Several popular protocols in the DeFi space, such Maker and Compound, have launched DAOs to fundraise, manage financial operations, and decentralize governance to the community.

6. Margin Trading

DeFi margin trading is supported by decentralized, non-custodial lending protocols like Compound and dYdX, as opposed to traditional finance, where margin traders can leverage their trades by borrowing money from a broker (which subsequently serves as collateral for a loan). Some have started talking about the advent of “autonomous money markets” in the DeFi ecosystem since smart contracts automate traditional brokerage activity.

7. Derivatives

Ethereum-based smart contracts enable the creation of tokenized derivatives whose value is derived from the performance of an underlying asset and in which counterparty agreements are hardwired in code. DeFi derivatives can represent real-world assets such as fiat currencies, bonds, and commodities, as well as cryptocurrencies.

8. Infrastructure for Building on the Blockchain

The ability for various parts of a system to connect and work together, is one of the fundamental architectural tenets of DeFi protocols. This has produced a potent network effect that allows the developer community to continue building upon what others have developed, as can be seen from the large variety of integrated DeFi apps some of which leverage on Bitpowr API suit to build and launch in days.

9. Insurance DeFi

There are several insurance policies built on the blockchain that cover real-world events like farming, disasters, and more. A parametric insurance model is used by several blockchain-based insurance policies, in which claims are paid to the interested party as long as certain conditions are satisfied. To determine when distributions should take place, these parametric insurance policies frequently use hardware and software oracles. With the help of smart contract technology, payments are made automatically rather than waiting for a central authority to do so.

10. DEXs

One of the core features of DeFi is Decentralized Exchanges (DEX). With the help of DEXs, users can swap or exchange tokens for other assets and intermediaries are not required. Similar alternatives are available on traditional exchanges (centralized exchanges), but the investments offered are dictated by the exchange’s policies and expenses.

Conclusion

There is a reason why DeFi has captured our attention, the total value locked in DeFi protocols alone has surpassed $100 billion.

Also, DeFi has significantly reduced the cost of producing and distributing various assets, much like the internet did for publishing and advertising. One reason for the lower costs is DeFi’s peer-to-peer lending mechanism, which eliminates the need for a third-party intermediary. This means that an institution seeking credit does not have to pay a fee to a bank or another financial institution to obtain it.

Bitpowr’s infrastructure is also playing a significant role in advancing the DeFi course by providing DApps wide access across EVM-compatible protocols without compromising institution-required security, operational efficiency, or compliance requirements.

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