The earliest form of market exchange was peer to peer, also known as barter. Barter was highly inefficient because supply and demand had to be exactly matched between peers. To solve the matching problem, money was introduced as a medium of exchange and store of value. Initial types of money were not centralized. Agents accepted any number of items such as stones or shells in exchange for goods. Eventually, specie money emerged, a form in which the currency had tangible value. Today, we have non-collateralized (fiat) currency controlled by central banks. Whereas the form of money has changed over time, the basic infrastructure of financial institutions has not changed.
DeFi is an abbreviation for Decentralized Finance and can be described as a system of financial services implemented through the blockchain, without the participation of large financial organizations such as banks. However, it employs smart contracts which are digital contracts created and enforced on the blockchain platform to execute human tasks.
DeFi or decentralized finance seeks to build and combine open-source financial building blocks into sophisticated products with minimized friction and maximized value to users using blockchain technology.
DeFi is fundamentally a competitive marketplace of decentralized financial applications that
function as various financial “primitives” such as exchange, save, lend, and tokenize.
These applications benefit from the network effects of combining and recombining DeFi products and attracting increasingly more market share from the traditional financial ecosystem.
Five Key Problems of Centralized Financial Systems
- Centralized Control
- Limited access.
- Inefficiency
- Lack of interoperability
- Opacity
Key Features of DeFi:
- Decentralization: Operates on blockchain networks, primarily Ethereum, without centralized authorities.
- Smart Contracts: Automates processes, reducing reliance on intermediaries.
- Transparency: Transactions are recorded on a public ledger, allowing users to verify details.
- Accessibility: Anyone with an internet connection can participate, removing geographic and financial barriers.
- Interoperability: DeFi applications can integrate and interact with one another, creating a composable ecosystem.
Examples of DeFi Services:
- Lending and Borrowing: Platforms like Aave and Compound allow users to lend their assets to earn interest or borrow against their holdings.
- Decentralized Exchanges (DEXs): Platforms like Uniswap and SushiSwap enable peer-to-peer trading of cryptocurrencies.
- Stable coins: Cryptocurrencies pegged to assets like USD, e.g., DAI or USDC, for minimizing volatility.
- Yield Farming: Users earn rewards by providing liquidity to DeFi platforms.
- Derivatives and Insurance: Tools for risk management and speculative trading.
DeFi Infrastructure:
- Blockchain
- Cryptocurrency
- The Smart Contract Platform
- Oracles
- Stablecoins
- Decentralized Applications