What is Decentralized Finance (DeFi)?

Decentralized Finance (DeFi): Revolutionizing Finance with Blockchain Technology

An umbrella term representing a collection of financial products & services created over the DLT

DeFi or Decentralized Finance is an umbrella term representing a collection of financial products and services created and offered over the distributed ledger technology. The intermediation of financial institutions is de-necessitated by these protocols with the use of cryptographic proof of transactions.

These protocols also make use of advanced tools like programmed smart contracts and tokenization to design innovative financial products offered to the participants of the blockchain peer-to-peer network.

The DeFi ecosystem appeared with smart contract enabled blockchain platform Ethereum going live in 2015 and today has proliferated to more than 250 protocols with over $100 billion in total value locked (TVL) in these protocols.

The DeFi ecosystem is rapidly innovating and emerging with wonderful new products which are disrupting the financial products and services marketplace.

These products include stablecoins, decentralized exchanges, decentralized lending and borrowing platforms, decentralized asset management tools, decentralized autonomous organizations or DAOs and governance, insurance products, derivatives products, margin trading products, payment solutions, staking solutions, KYC and identity solutions, tokenization, yield aggregation platforms, prediction markets, infrastructure and development tooling products, analytics services among many such offerings.

The innovation in the DeFi segment is prolific and exciting. This segment is evolving rapidly as improved protocols are coming up with each innovative iteration and market offering. The blockchain projects are also evolving and so are the applications in the form of DeFi.

Decentralized Finance (DeFi): A Revolutionary Era in Finance

The returns of the DeFi instrument are quite handsome when compared to similar traditional finance products and services (traditional financial products & service marketplace is also referred to as CeFi — the acronym for Centralized Finance). This is possible because the smart contracts and decentralized consensus reduce the counterparty risks, monitoring and arbitration costs and also the costs of intermediation.

The programmable nature of the decentralized applications also provides the flexibility to order the best possible combinations of these instruments to maximize returns. This feature is given a very interesting term — it is called ‘Money Legos’ — indicating that parts can be joined together in a preferred order of precedence depending on the comfort of the user!!!

Oracles on the decentralized ecosystem connect the real-world trigger events to smart contracts enabling conditional execution of the same. This enables the creation of derivatives, prediction markets and a lot of other possibilities.

Tokenization of real-world assets helps granularization of high-value assets helping address a wider investor base and also brings them into the digital realm transcending the geographical boundaries helping cater to a larger digital global audience.

The programmability of the decentralized applications in the financial realm helps create bespoke products for the users providing for many interesting innovations in this area. Currently, as the craze of DeFi grips and drives the imagination of investors — we can say we are in for some very interesting times in this area.

However, along with the innovation, follows a caveat. The DeFi segment is not regulated at the moment. Therefore, users have to be extremely careful with their research of the DeFi project before participating in it and availing its benefits.

Choosing based on the returns only may not be a judicious approach at the moment.

One must DYOR (Do Your Own Research) meticulously and observe the proliferation of any project closely before participating in it. One may also avail of the services of several audit companies who specialize in auditing the security and other features of the smart contracts published by the project.

If one covers the risks well, DeFi is one segment that would provide the early adopters with exciting returns.

For more such knowledge bytes please explore the various courses offered by 3.0 University.

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