Summary
- DeFi is an umbrella term for financial services that operate on the blockchain.
- An alternative to traditional finance (TradFi), it supports many of the same activities that are associated with banks and banking.
- It has the potential to create more open, free, and fair financial markets, accessible to anyone with an internet connection.
- For more articles like this, please visit our Explainers pages.
Defining DeFi
DeFi, or decentralized finance, is an umbrella term for financial services on public blockchains, primarily Ethereum.
DeFi supports many of the same activities of banks – earning interest, borrowing, lending, buying insurance, and trading derivatives and assets – but it’s faster and doesn’t require paperwork or a third party.
As with crypto generally, DeFi is global, peer-to-peer (i.e. directly between two people, not routed through a centralized system), pseudonymous, and open to all.
Why is DeFi important?
DeFi takes the basic premise of digital money and expands it, creating an entire digital alternative to Wall Street, but without the associated costs of things like office space, trading floors, and banking salaries. This has the potential to create more open, free, and fair financial markets, accessible to anyone with an internet connection.
What are DeFi’s benefits?
- Open: Users don’t need to apply for anything or open an account, which is vital for those who have historically struggled to access the traditional financial system.
- Flexible: Users can move their assets anywhere at any time, without asking for permission, waiting for long transfers to finish, or paying expensive fees.
- Fast: Elements like interest rates typically update rapidly (as quickly as every 15 seconds).
- Transparent: Everyone involved can see the full set of transactions.
How does it work?
Users typically engage with DeFi via software called dapps (decentralized apps), most of which currently run on the Ethereum blockchain. Unlike a conventional bank, there is no application to fill out or account to open.
The types of activities individuals use DeFi for include lending, obtaining loans, trading, saving, and buying derivatives.
What are the downsides?
- Fluctuating transaction rates on the Ethereum blockchain mean that active trading can get expensive.
- Depending on which dapps are used and how, investments can experience high levels of volatility.
- Users have to maintain their own records for tax purposes, and be cognisant that regulations related to issues like taxation can vary from region to region.
A version of this explainer first appeared on Coinbase.
