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What Is DeFi and How Does It Work?

DeFi (or decentralized finance for short) is a new way of maintaining banking and financial services. The main idea of the DeFi platform is to handle peer-to-peer payments that take place within the blockchain network. As a result, consumers have a chance to avoid third parties and financial intermediaries such as brokers or banks. Today, we call it “trust-less” banking.

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In this article, we will explain what DeFi is, how it works, as well as the main pros and cons of using decentralized finance.

DeFi Definition and Meaning Explained

As stated earlier, the term “DeFi” stands for decentralized finance. It was developed to deliver multiple financial services to meet both business and individual needs. Customers can complete transactions, transfer payments, and so on. Companies have a chance to sell insurance, and provide loans, deposits, and other financial products.

For investors, a DeFi platform can turn into a personalized banking account without actually a bank. They can send money faster as well as benefit from higher yields compared to those available with conventional banking accounts. It means zero banking fees and commissions as well as the ability to send funds anywhere around the globe.

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The Importance of Using DeFi Platform?

DeFi takes and expands BTC’s basic premises. As a result, we currently have a self-sufficient digital infrastructure of a digitalized alternative to Wall Street, if you want. The main difference between conventional exchange and the Defi platform is the fact that the second one does charge associated costs to maintain trading floors, brokers’ salaries, bankers’ fees, etc.

Additional benefits include the following:

  1. Simplicity. To open an account, you only need to create a wallet. No application or registration forms to complete.
  2. Anonymity. The system does not require submitting any personal data. Your contact info and other personal data are safe.
  3. Freedom. Users can send their assets peer-to-peer anywhere across the globe. You do not need to ask permission from the bank when the sum exceeds the limit. Additionally, users do not pay high fees for each transaction.
  4. Fast payouts. Investors will appreciate fast rewards and interest rate updates (every 15 seconds on average). Besides, they can be higher compared to Wall Street rates and rewards.
  5. Clarity. Each transaction is 100% transparent no matter if it is initiated by a company or individual. Usually, businesses do not share this information or provide misleading facts. With DeFi, 100% transparency is guaranteed to make it perfect for investors.

Now, let’s have a look at how different market participants can benefit from using decentralized finance.

Who Can Benefit from Using DeFi?

To complete the operation, users generally have to deal with DeFi apps also known as dapps. The majority of them were developed to run within the Ethereum-based blockchain. As mentioned earlier, to use the app one should not provide any personal information.

The following categories may currently benefit from decentralized finance:

  • Traders – trade certain crypto coins on a peer-to-peer basis. It works the same as buying or selling stocks without using a broker.
  • Investors – DeFi makes it easy to buy derivatives as well as make long and short bets on certain instruments. In other words, we have an alternative version of the platform to trade futures contracts.
  • Lenders – individuals and companies can lend cryptocurrency to earn rewards and interest rates that are paid on a monthly basis.
  • Borrowers – individuals and businesses can apply for a loan in crypto without tons of paperwork and weeks of waiting for approval. Additionally, users can benefit from so-called flash loans that the majority of financial institutions do not offer.

DeFi Disadvantages

It all may sound too good to be true. A new environment with low fees and fast transactions. However, DeFi is far from perfect, at least for now. It comes with several downsides that are very important to consider before using it.

First of all, active trading can still be very expensive despite the lack of intermediaries and third-party fees. Transaction rates on the Ethereum blockchain are fluctuating all the time making them hard to predict in the short perspective.

Secondly, some DeFi apps can lead to extreme volatility. Last but not least, users are the only ones responsible for maintaining their tax records. Keep in mind that different regions establish their own regulations.

Bottom Line

DeFi has enormous potential. It develops an alternative financial infrastructure based on peer-to-peer transactions within the Ethereum blockchain. At the same time, the technology is new. On the one hand, it offers higher yields and lower commissions.

On the other hand, it still blinds the potential return to other risks that are still to manage and resolve. Also, take into account a growing number of scams and thieves who can wipe out all your coins right at once. In fact, this particular thing may currently happen to any crypto market participant.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.