What is Decentralized Finance (DeFi)?

Have you heard of decentralized finance and wondered why all the hype?

You have come to the perfect place. In this article, we will answer all your questions.

• What is decentralized finance?
• How is decentralized finance different from traditional finance?
• How to evaluate DeFi tokens?
• How to get started with DeFi?
• And finally, what are the examples of DeFi applications?

Having explained what "Yield Farming" is, and glimpsed the potential of new passive income generation devices offered by the crypto industry, now is the time to get down to business. We therefore continue to understand this new crypto continent by learning the fundamentals in this new chapter of the Decentralized Finance Tribune.

This content is offered to you as part of a partnership with CryptoTesters.com, a platform specializing in reviews and analyzes of DeFi services and on which you will learn a little more at the end of the article.

What is decentralized finance (DeFi)?

Decentralized finance is one area of ??cryptography that is receiving special attention today. In its greatest ambition, DeFi aims to recreate the financial system we use today, but in a way that would remove all trusted intermediaries like banks.

Bitcoin, the first decentralized network, to have laid the foundation for this movement by facilitating trustless peer-to-peer payments. This means that you can send bitcoin to anyone in the world without knowing or trusting that person AND without using a third-party service like a bank. In addition to these features, bitcoin has other attributes hard-coded into its protocol. Perhaps most important is the supply cap, which predicts that there will never be more than 21 million bitcoins in total. This scarcity explains why bitcoin is often referred to as “digital gold”.

Once people recognized the power of the Bitcoin network, they immediately began to think about how it could enable more use cases beyond simply storing bitcoin ownership status.

Determined to find a solution to this problem, a young Bitcoin enthusiast named Vitalik Buterin set out to create Ethereum in 2013. Technically, Ethereum is a kind of “world computer” that can store both code and data. data. Like a normal computer, Ethereum can execute code and it uses the Ethereum blockchain as a hard drive. Every time code is executed and data is changed, the status of the blockchain is updated. However, unlike a traditional computer, Ethereum's state changes are governed by consensus rules and the state is globally distributed, meaning that data is collectively held by thousands of nodes.

These building blocks make Ethereum the ideal candidate for hosting new types of applications. Applications which are:

Decentralized - Applications which can operate without a single central entity controlling them and which are governed by their users.

Censorship Resistant - Applications that cannot be obstructed by a government or other actor.

Unauthorized - Apps that can be built and used by anyone in the world without any geographic limitation.

While in theory Ethereum can accommodate any type of application, decentralized finance is the area that is currently the most explored. Decentralized finance encompasses a wide range of applications that aim to replace banks and other financial institutions, that is, applications that revolve around trade, lending, borrowing and investing.

What are the differences between traditional finance and decentralized finance?

In traditional finance, when you visit your banking institution's website or your mobile application, all the logistics of the application are hosted on a server controlled by your bank. Your bank account balance and personal information are also stored in a database controlled by your bank. Decentralized finance upsets this logic. We'll take a look at some of the differences between using a bank account and using a DeFi app.

Deposit and storage

In decentralized finance, your assets are stored in a blockchain account rather than in a database. While your bank can freeze your holdings at any time, no one can prevent you from accessing your holdings on the blockchain. There is no single server that can be shut down. To deprive you of your assets, someone would have to shut down the entire blockchain, which is almost impossible given that it is managed by thousands of computers spread across the world.

Your account is not represented by a name and bank account number, but by a pair of public and private keys. The public key is ... public and identifies you on the network (for example when you want to receive funds from a friend) and the private key is the one you need when you want to send funds to another Ethereum account. Minors verify all transactions and only validate those with genuine digital signatures.

Opening an account on the blockchain is completely free. If you're tech-savvy, you can spin a node and generate as many addresses and accounts as you want. However, most of the users use an Ethereum wallet to create an account. Wallets are interfaces that make it easy to interact and communicate with the Blockchain. When you download a wallet and set it up, the wallet automatically generates a public key and a private key. When you send credit notes to another address, your wallet produces the necessary signatures and submits the transaction to the blockchain, where it is then processed and validated. In short, the wallet is your ticket to the existing financial system on the Ethereum blockchain.

Unlike a bank account where you have to log in, no one will deny you an Ethereum wallet. They are all free and open-source.

Frictionless

Another difference between an Ethereum account and a bank account is that the former gives you complete freedom over which interface you want to use.

You can download an Ethereum wallet, copy its private key, then import it into another wallet app, and you will see your balance immediately appear in the interface. Imagine being able to import your bank account into the banking application of your choice and switch from Societe Generale to Boursorama in seconds. This is a reality in the crypto world, because a wallet is just an interface that reads the blockchain. This blockchain is public and accessible to everyone.

Switching from one DeFi application to another is just as seamless. The concept of "signing up to a website" and having an unwavering link with a supplier does not exist. If you want to use a DeFi app, you need to go to the website where the app is hosted. As soon as you have connected your wallet, you can use the application. You are "identified". The only difference is that no personal data is stored. You can switch from one application to another in seconds.

Without authorization

What's more, on Ethereum, developers can start building whatever they think of. They don't have to ask for permission and there is no paperwork. In traditional finance, it is extremely difficult to build a product. Especially if you are trying to build something new. It has stifled innovation in finance over the past decades.

On Ethereum, literally anyone can create an app. Developers who have an idea of ??how to build a more efficient exchange, synthetic dollar, or options market than existing markets, can simply do it. For the first time in history, developers around the world are joining forces and building on the same platform. While the traditional financial system is extremely fragmented, Ethereum provides a global settlement platform that transcends borders and nationalities. A sandbox for innovation.

Interoperable

Another key feature of decentralized finance is that all smart contracts are public, readable, and available on the chain. Open source by default. Anyone who knows how to code can trigger the functions of these smart contracts. Therefore, anyone can also interface with these smart contracts.

For example, the team behind Uniswap, a decentralized exchange that allows users to exchange tokens, has developed an interface that users can visit on uniswap.exchange but there are many other interfaces that are hosted by other teams. and individuals. This means that not only the backend of these applications - i.e. smart contracts - cannot be dismantled, but even the frontends / interfaces resist censorship and are decentralized. The teams behind smart contracts are even encouraging this by making the frontend code public as well.

But there is another cool feature of these smart contracts. Because they are public and exist on the same IT platform, they can interact with each other. This is called interoperability. This basically means that if I build a new app, I can integrate all of the existing smart contracts into my app.

Let's say I create a lending protocol. The loan protocol has two main functions. Users can deposit money into a mutual fund and earn interest on it. And borrowers can borrow assets from that same pool. However, to secure the loan, they will need to deposit assets as collateral for the loan. This procedure is similar to that used for loans in the traditional finance industry, which are secured by a mortgage or other collateral.

But what happens when the value of the crypto currencies held as collateral for the loan by the protocol drops to 0 and the borrower does not repay the loan? To ensure that this could not happen, the protocol would need a liquidation mechanism by which it would sell the risky collateral of borrowers in the market and repay lenders. Instead of having to build an exchange from scratch, as well as a lending market, I can simply integrate Uniswap into my protocol. Whenever collateral is at risk, the protocol grabs it and sells it on Uniswap. The proceeds of the sale go directly into the protocol pool and guarantee its solvency.

Interoperability is a powerful notion because it means that every new application being built can benefit from existing ones. With each application being built, Ethereum as a whole becomes more useful and powerful. This is the reason why Ethereum is so dominant. No developer wants to build on a Blockchain without apps. Even if it promises millions of transactions per second.

Governance

In the traditional world, businesses (like your bank) are managed by executives, usually overseen by a board of directors and ultimately owned by shareholders.

The vast majority of companies are private, which means stocks are not publicly traded and the average citizen cannot buy a share of the property. Those that are public are relatively expensive when listed on the stock exchange. By the time a company like Facebook goes public, venture capital funds have already made their profits. They invest in companies when they are very cheap and sell their stocks to the public years later at prices reaching billions of dollars.

In contrast, most protocols are owned and governed by their community. Anyone can submit proposals or code changes to a protocol, which are then accepted and implemented or rejected by the community. To participate in decision making, users must purchase the governance token. Token holders also usually receive a portion of the fees the protocol collects for its services.

How to get started with Decentralized Finance - DeFi?

To get started with decentralized finance, you will need some Ether and a wallet.

To buy Ether, you need to go to a centralized crypto exchange (like COINBASE or Kraken). Exchanges allow you to convert your fiat currencies into cryptocurrencies. Once you have acquired Ether, you must transfer it to an Ethereum Wallet.

1. Buy Ether (ETH)

2. Get an Ethereum wallet

3. Withdraw your ETH from the exchange

4. Start using DeFi