Decentralized Finance (DeFi) Definition

What Is Decentralized Finance?

Decentralized finance (DeFi) is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. The system removes the control banks and institutions have on money, financial products, and financial services.

Some of the key attractions of DeFi for many consumers are:

It eliminates the fees that banks and other financial companies charge for using their services.

You hold your money in a secure digital wallet instead of keeping it in a bank.
Anyone with an internet connection can use it without needing approval.
You can transfer funds in seconds and minutes.

Understanding DeFi

To understand decentralized finance and how it works, it helps to understand how centralized finance differs from DeFi.

Decentralized Finance

Decentralized finance eliminates intermediaries by allowing people, merchants, and businesses to conduct financial transactions through emerging technology. This is accomplished through peer-to-peer financial networks that use security protocols, connectivity, software, and hardware advancements.

From anywhere you have an internet connection, you can lend, trade, and borrow using software that records and verifies financial actions in distributed financial databases. A distributed database is accessible across various locations; it collects and aggregates data from all users and uses a consensus mechanism to verify it.

Decentralized finance uses this technology to eliminate centralized finance models by enabling anyone to use financial services anywhere regardless of who or where they are.

DeFi applications give users more control over their money through personal wallets and trading services that cater to individuals.

How Does DeFi Work?

Decentralized finance uses the blockchain technology that cryptocurrencies use. A blockchain is a distributed and secured database or ledger. Applications called dApps are used to handle transactions and run the blockchain.

In the blockchain, transactions are recorded in blocks and then verified by other users. If these verifiers agree on a transaction, the block is closed and encrypted; another block is created that has information about the previous block within it.

The blocks are “chained” together through the information in each proceeding block, giving it the name blockchain. Information in previous blocks cannot be changed without affecting the following blocks, so there is no way to alter a blockchain. This concept, along with other security protocols, provides the secure nature of a blockchain.

In DeFi, you’d use your decentralized finance application (dApp) to enter your loan needs, and an algorithm would match you up with peers that meet your needs. You’d then need to agree to one of the lender’s terms and receive your loan.

The transaction is recorded in the blockchain; you receive your loan after the consensus mechanism verifies it. Then, the lender can begin collecting payments from you at the agreed-upon intervals. When you make a payment via your dApp, it follows the same process in the blockchain; then, the funds are transferred to the lender.

DeFi Currency

DeFi is designed to use cryptocurrency for transactions. The technology is still developing, so it is difficult to determine precisely how existing cryptocurrencies will be implemented, if at all. Much of the concept revolves around stablecoin, a cryptocurrency backed by an entity or pegged to fiat currency like the dollar.

What Does Decentralized Finance Do?

The goal of DeFi is to get rid of the third parties that are involved in all financial transactions

Is Bitcoin a Decentralized Finance?

Bitcoin is a cryptocurrency. DeFi is being designed to use cryptocurrency in its ecosystem, so Bitcoin isn’t DeFi as much as it is a part of it.

What Is Total Value Locked in DeFi?

Total value locked (TVL) is the sum of all cryptocurrencies staked, loaned, deposited in a pool, or used for other financial actions across all of DeFi. It can also represent the sum of specific cryptocurrencies used for financial activities, such as ether or bitcoin.