Decentralized Finance (DeFi) is an alternative to the traditional banking sector. This includes blockchain-based applications and services that enable digital transactions between participants without intermediaries. According to the crypto community, the current financial system is outdated, not transparent and has a high level of control.
DeFi allows you to replace traditional technologies with open source protocols, which gives access to financial services to everyone. These finances are serviced by users of the system. At the same time, projects remain open, there are no regulatory authorities that can block a payment or block access to any service.
Among the services are lending, investments and the purchase of crypto assets. With DeFi, services that used to be characterized by low processing speeds and high risks of human error have become automatic and secure. Decentralized finance provides an opportunity to receive passive income from owning cryptocurrencies, save on transactions and loans.
How traditional finance differs from DeFi
To understand the essence of decentralized finance and its popularity, it is important to understand how it differs from centralized or traditional finance. Consider the main problems in the classical banking sector that DeFi is already solving today:
Not all people have access to banking services.
There are hidden fees for using financial services.
Money transfers take time.
Financial institutions work according to the schedule.
In the classic banking sector, money is kept in banks or other financial institutions whose sole purpose is to make money. Transactions are processed using third party services that charge fees for their intermediary services.
Example: when paying for purchases in a store using a card, the data from the seller goes to the bank, then to the credit card network, after which the payment is requested from the bank. The bank then approves the payment and sends a confirmation to the seller's bank.
Each participant in these operations receives payment for services. The consumer pays to own the card, and the merchant pays to receive the consumer's money. Decentralized finance eliminates intermediaries, allowing participants in financial transactions to carry out the process directly and quickly.
Operations take place using peer-to-peer networks that use security protocols, connectivity, software and hardware. Therefore, a DeFi user from anywhere in the world using the Internet has the opportunity to buy and sell assets, lend them and take out loans. Users can control their finances in personal wallets and payment services.
Programs record and verify actions in distributed databases that collect information from network users and use verification mechanisms.
How the DeFi System Works
Decentralized finance uses blockchain technology, which underlies all cryptocurrencies. Blockchain is a distributed and secure database. Decentralized applications (DApps) are used to run the blockchain and process transactions.
In the blockchain, all transactions are recorded in blocks and are subsequently verified by other network users. If they agree to the transaction, then the block is closed and encrypted. Then a new block is created that contains information about the previous block.
Each block is associated with the new information that it contains - this is called the blockchain. Information in previous blocks cannot be changed without adjustments in the following blocks, so it is not possible to edit the blockchain.
What services do DeFi provide?
Decentralized finance uses cryptocurrencies and smart contracts to provide financial services without the involvement of banks as intermediaries. Popular DeFi Features:
Fast money transfers around the world.
Storage of cryptocurrencies on wallets.
Issuing and receiving loans.
Cryptocurrency trading at any time of the day.
Toned asset options.
How to make money in DeFi
One of the popular ways to make money in DeFi is passive income from lending applications that operate on the Ethereum network. Users give loans and receive interest from the use of these funds by other network users.
You can make money on farming or profitable farming, but this is already a risky direction. Here, the user's crypto assets are blocked in the pool to receive interest. Therefore, users are exploring many DeFi tokens in order to get the best farming bonuses.
There are ways to get passive income just from storing coins in a personal wallet.
What are the risks of decentralized finance
Decentralized finance is associated with crypto assets, so it is too risky. There is no controlling body in the system, and this attracts scammers. According to various sources, the increase in the number of fraudulent transactions in 2021 in comparison with the statistics of 2020 exceeded 100%.
Fraudsters release high farm tokens
rsky income in the hope of attracting increased attention to his project. With active trading in the pool and a strong appreciation of the token, they withdraw all funds from the project and disappear with them.
High volatility in the price of tokens is another risk of DeFi along with the minimal value of new projects. Often these can be copies of popular protocols that don't last very long and investors end up losing money.
What is the future of DeFi
Decentralized finance is still in its early stages of development. Despite the strong growth in 2020, the community expected the closure of such projects. But the sphere continues to develop, and interest from investors is steadily growing.
However, DeFi is not regulated in any way, and failures, hacks, and scams are still common here. According to Elliptic, users have already lost about $10.5 billion. Analysts believe that vulnerabilities in DeFi projects are larger than those in traditional banking and thus threaten global financial stability.
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