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Decentralized finance is, in a nutshell, peer-to-peer financial services that flip the typical stratification of control that has usually been associated within a given source and, rather, takes the locus of control and centers it around you, the consumer. They are decentralized applications that provide financial services to their users without the need for an intermediary between the transaction. On top of this, there are also numerous kinds of DeFi applications to choose from (with many operating on the Ethereum blockchain) so it actively challenges the nature of having finances becoming monopolized (more on this later).
In a nutshell, decentralized finance takes crypto assets and smart contracts and removes the monopoly institutions have on financial services and financial products. Ultimately, in the end, DeFi is interested in removing third parties and the power provided to institutions that act as guarantors for your transactions and puts you, the user, at the center instead.
What is Centralized and Decentralized finance?
Another way to look at these two camps of finance is to consider how the game of Monopoly is played. In the game, one player takes on the role of the banker (usually determined among the players) and proceeds to distribute money to players as needed. They also provide loans and conditions of those loans to players who find themselves in need. In moments where property has been auctioned from their owner, the bank ensures that no rents are provided until the value of that auctioned property has been repaid. Additionally, this role oversees the auctioning of properties between trades, as well as operating in the space needed to ensure both parties who are transacting business are doing so based on parameters that are set (meaning that if there are private trades, the banker ensures that it goes through).
In this example of the game Monopoly, this is very much aligned to a “centralized” source providing, determining, and/or allowing financial services to be transacted. Users come to “it”, “it” gets to make decisions, “it” has a physical and virtual space that users have to come to, and “it” has the power dynamic control. It is the middle-person between you and your money.
For decentralized finance, this is mostly, if not entirely, scrubbed. For one, the reliance upon having to use this source as the entity between yourself and your money is removed; instead, decentralized finance (DeFi) uses smart contracts on blockchain technology. Your digital assets in your crypto wallet are available to you, at any time (of course as long as there is an internet connection), so there is no issue with having to schedule around the operating hours of a centralized source.
Why is finance decentralized?
There are many, many reasons why finances should be decentralized. Let’s continue with the example of Monopoly. Being the banker in Monopoly may mean a lot of work, but one of the unspoken benefits of being the banker (if you modify your game with additional “allowances” like we do) is that you may be able to slip yourself some extra money if no one is looking. Perhaps even cater to particular players, perhaps, if they provide you some favors.
While this is not to say that all games of monopoly are like this, nor is it an endorsed practice of the game itself, but it shows some of the detraction associated with centralized finance; it does provide the opportunity, the environment, and the possibility of this occurring. With decentralized finance, it is far less likely. By decentralizing finance using peer to peer networks, it removes some of the financial bureaucracy that overviews financial transactions and makes them transparent for any parties involved.
Is decentralized finance good?
In short, there are various advantages to decentralized finance that you don’t always tend to get with a centralized source. Again, with a centralized finance model, institutions holding a monopoly on financial decision-making means that they are able to determine everything on their own. If we are to examine lending and borrowing practices, in a traditional model of finance an institution can set any and all parameters of the process; after all, you have to come to them because “they” have what you want. For DeFi, users can transact directly with other users with the user that lends setting their own determination for, say, interest rates, and the receiving user accepting the terms and conditions supplied.
With DeFi, you are also able to engage in flash loans which use smart contracts as digital agreements that are scribed into the blockchain. They cover the entirety of the loan, from the agreement to the paying back of it, in one single transaction (rather than having loans paid back over time, the total amount of the loan must be repaid in one transaction).
How much is decentralized finance worth?
There are some variations on determining this, but it is worth noting that DeFi itself has captured a relatively small amount of space on the cryptosphere; however, it accounts for close to $200 billion as of February 2022.
How do I invest in decentralized finance?
Most DeFi use some form of centralized finance coins associated with their networks (also called native tokens). So, if you would like to pursue investing in its future, you would want to secure these coins (of course you should be doing your due diligence in researching the DeFi networks, protocols, and other various aspects of the application before you make your call).
How do you make money with DeFi?
Often, what DeFi offers to people in terms of making money is found through the application of passive-driven income (though, again, this is not the only way). For large scale operations, businesses are able to use smart contract features and integrate them in order to make the transaction processes automated to their terms. You are also able to stake your crypto assets into DeFi protocols where you are able to yield it which allows your crypto to grow without risk of losing it via trading or other means of effect. Or you can always become a lender yourself and offer your own terms of lending on various decentralized exchanges that others can review.
While there are risks to anything, there is some relative safety in DeFi in order to turn a profit.