DeFi (short for Decentralized Finance) refers to the decentralization of existing traditional financial services and products leveraging the use of blockchain. DeFi aims to host traditional financial services, such as banking and lending services, on blockchain technology, eliminating the need for middlemen and institutions like the actual banks themselves.
How does decentralized finance work?
DeFi ecosystem is currently undergoing a lot of development as it is still in its early stages, with several use cases still being identified. Such was the vision of Ethereum’s founder, Vitalik Buterin, who created the Ethereum blockchain to enhance the use cases of blockchain technology beyond a store of value.
DeFi applications are powered by Ethereum’s smart contract functionality. Smart contracts are immutable self-executing programs that run on a blockchain that execute transactions based on certain predefined conditions. Once the conditions are met, the smart contract is executed, thus removing the need for financial intermediaries.
These smart contracts facilitate peer to peer transactions between buyers, sellers, lenders, and borrowers and each transaction is recorded in the public blockchain ledger. This offers a more transparent, secure and trustless financial system without depending on central authorities.
What are DeFi applications?
DeFi applications are known as dApps – short for decentralized applications. They serve as the user-friendly layer for interacting with decentralized finance protocols, i.e. DeFi protocols – the smart contract functionality which provides a specific DeFi use case such as lending and borrowing of assets.
Popular examples of dApps include decentralized exchanges (DEXs), lending/staking platforms, and crypto wallets.