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Decentralized Finance Meaning

Jan 1, 2023 | Updated May 24, 2023
Decentralized Finance (DeFI) refers to financial applications and services that are built on a blockchain and operate without a central governing authority (hence, “decentralized”).

What is Decentralized Finance?

Decentralized Finance or DeFi is an umbrella term that refers to financial applications built using blockchain technology, mostly on the Ethereum network. DeFi was developed as an alternative to the more centralized traditional financial system. DeFi uses smart contracts – blockchain-based programs that execute a given action when predetermined conditions are met – to operate services without a central authority. Users interact peer-to-peer, with interactions governed by the smart contract of the protocol.

The Ethereum blockchain was the first to introduce smart contract functionality. This is the origin of DeFi, and most applications are still on Ethereum today.

Decentralized Finance has several functions in the cryptocurrency market, including:

  • Peer-to-peer lending and borrowing 
  • Decentralized financial services, such as insurance
  • Stablecoins
  • Staking and yield farming
  • Decentralized exchanges, such as DEXs and AMMs.

DeFi vs CeFi 

Traditional Banks are the best examples of centralized financial entities. You use banks to create an account and save money, take loans and send money. As middlemen , The banks hold significant power; they can demand significant personal data, extensive credit checks before giving access to loans and services and limit certain transactions  to banking hours. In contrast, DeFi removes the need for  third-party involvement: thanks to smart contract based protocols, users can access financial services with only a crypto wallet and internet connection. 

The DeFi ecosystem operates 24/7, is accessible to anyone, and provides much more privacy than traditional banks. You can secure your cryptocurrencies in hardware or software wallets to ensure control over your assets. A major perk of DeFi is the shorter processing time for transactions, like loans or staking. 

DeFi also gives users a way to generate income on their digital assets by contributing to lending pools which are used for offering collateral-backed loans to other users. 

What is the Difference Between Blockchain, Cryptocurrency, and DeFi? 

Blockchain is a digital ledger that stores information and transaction histories; it is the foundation for crypto and DeFi.  

Cryptocurrencies are units of value hosted on the blockchain, and are units of exchange in the DeFi ecosystem. 

DeFi is the ecosystem of decentralized financial services enabled by smart contracts on the blockchain.

Sybil Attack

A Sybil attack is a security threat on a peer-to-peer network where a malicious actor attempts to sabotage the network’s reputation by creating multiple fake identities.

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A testnet is like a practice version of the main blockchain network. It lets developers test new ideas and features without affecting the main network.

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Stablecoins are a type of cryptocurrency that is pegged or tied to another asset, such as fiat currencies or gold.

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