August 31, 2022

All About Defi – Decentralized Finance

IT Tips & Insights: A Softensity software engineer details the pros and cons of decentralized finance.

By Alvaro Ribeiro, Software Engineer

What is Defi?

Defi is a decentralized peer-to-peer network that offers access to financial services to anyone, with no central authorities, relying on blockchain and smart contracts. There’s no human operating these financial services, which reduces the cost of the services, decreasing the errors, and increasing the efficiency of the services offered. While in a traditional financial institution there are lots of layers of processes and bureaucracy, to join a Defi application all we need is a crypto wallet (smartphone app) and internet connection.

The First Defi

Bitcoin is considered the first Defi network created, since it allows us to send and receive funds around the world without the need of a centralized institution. Moreover, it provides a way of exchanging tokens with other people using a shared ledger, registering all transactions, and leveraging its immutability nature, which means, once the transaction is registered, it cannot be deleted or modified. However, bitcoin is very limited, since it doesn’t provide a complete infrastructure of smart contracts like the Ethereum network (largely used for smart contracts and Defi networks).

Problems with Traditional Finance

  • Many people don’t have access to financial services
  • People may not get a job if they don’t have a bank account
  • Institutions can block access to a bank account anytime
  • Money transfers are expensive and may take days
  • Governments and institutions can close accounts at their will
  • High fees
  • No privacy

How Does Defi Work?

A Defi network (or protocol) is a collection of smart contracts (programming code), that run on the blockchain. The most popular blockchain for implementing Defi protocol is Ethereum, due to its design of supporting complex smart contracts. The source code of the smart contracts is usually open source, and they are available to anyone to audit and to make sure they can trust in the protocol. Users can use a Defi protocol to perform banking operations, such as fund transfers, borrow, lend, exchange assets, and so forth. 

A Defi protocol allows users to have easy, cheaper and efficient access to financial services, since there’s no middleman. As an example of a Defi network, we have Uniswap. Uniswap is one of the most popular Defi networks on the market, where millions of people can trade their tokens, borrow and lend at very low fees. Since Defi runs on the blockchain, anyone can view all the transactions and make sure everything is working properly. Since data on the blockchain is immutable, once a transaction is recorded, it cannot be undone.

Defi vs Traditional Finance?

Defi Traditional Finance
You hold your money A financial institution holds your money
Low fees High fees
Privacy No privacy
Open to anyone Needs permission from a company
Transfer of funds in seconds Transfers can take days
Open 24 hours Open 8 hours
Transparency – All transactions are registered in the blockchain No transparency

Applications of Defi

There are a large variety of financial services that can be performed on a Defi network, as shown below:

  • Traditional finance: Payments, trading securities and insurance, borrowing and lending.
  • Decentralized Exchange (Dex): Trade tokens, such as bitcoin and Ethereum, without using a traditional exchange (Binance or Coinbase).
  • Yield Harvesting: Allows investors to lend cryptos and earn interests.
  • Non-Fungible Tokens (NFTs): Allows individuals to create digital assets, such as media and art.

Risks of Defi

Although there are many advantages of Defi over the traditional finance system, there are risks and downsides of a Defi protocol, including the following:

  • No consumer protection: If a Defi protocol goes bankrupt, you may lose your funds, since there may not be protection and insurance of the funds, while in a traditional bank there’s insurance and partial protection of the funds.
  • Hacker attacks: If the Defi protocol is hacked and the funds are stolen, you may lose your funds.
  • Private key: You need to protect your private key (control your digital wallet), since it’s the only way you can access your funds. If you lose your key, you lose all your funds. Unlike with traditional banks, you hold your assets.

Conclusion

The Defi network was created to provide financial services using blockchain. Due to its decentralization, anyone can use the services, such as exchanging or borrowing/lending tokens. Advantages include accessibility, availability, cost and transparency. On the other hand, there are some risks, such as the lack of protection, and the responsibility of holding the assets on your own.

BIO

Hey people! My name’s Alvaro, I’m from Brazil and I’ve been working as a .Net Developer since 2005. Currently I’m working as a Senior Software Developer at Softensity. Although I enjoy programming with C# and .Net Core, I’m interested in Bitcoin and Blockchain applications in general.

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