Understanding Decentralized Finance (DeFi)
Decentralized Finance (DeFi) is an umbrella term for financial services offered on public blockchains, primarily Ethereum. DeFi encompasses a wide range of banking functions, such as earning rewards, borrowing, lending, purchasing insurance, trading derivatives, and more. However, DeFi processes transactions faster and without the need for paperwork or intermediaries. The key characteristics of cryptocurrencies, such as being global, peer-to-peer (meaning transactions occur directly between two people without a central authority), pseudonymous, and open to everyone, also apply to DeFi.
How Does It Work?
DeFi is typically accessed through applications called "Dapps" (decentralized apps), which mostly run on the Ethereum blockchain. Unlike traditional banks, there are no forms to fill out or accounts to open.
Why is DeFi Important?
DeFi builds on the same fundamental idea as Bitcoin—digital money—and expands it. This creates a complete digital alternative to Wall Street, but without the associated costs (such as office buildings, trading floors, and bankers' salaries). DeFi has the potential to create more open, cost-free, and equitable financial markets that are accessible with just an internet connection.
What are the Benefits?
Open Access
There’s no need to apply or open an account. You simply need to create a wallet to get started.
No Personal Information Required
You don’t need to provide your name, email, or any other personal details.
Flexibility
You can move your assets at any time without needing permission, long waiting periods, or paying high fees.
Speed
Interest rates and rewards can change quickly (sometimes every 15 seconds) and can be significantly higher than traditional Wall Street investments.
Transparency
All transactions are accessible to everyone involved (private companies rarely offer such transparency).
What are the Drawbacks?
Transaction Fees
The fluctuating transaction fees on the Ethereum blockchain can make active cryptocurrency trading expensive.
Volatility
Depending on which Dapps you use and how you use them, your investments can be highly volatile—this is a new kind of technology, after all.
Tax Reporting
You are responsible for documenting your transactions for tax purposes, and regulations can vary by region.
