Decentralized finance, commonly known as DeFi, is arguably one of the most important revolutions of our generation. This form of peer-to-peer financial (P2P) system has greatly reduced the bureaucracy in financial institutions and has the potential to enhance nearly all sectors of the economy.
Back in the day, people and businesses would have the need for a middleman like banks or brokerages to swap funds. Now, DeFi allows a direct financial relationship between all parties, making this process faster, more transparent, and also more cost-efficient.
This technology stands as the future of crypto payments, as blockchain technology expands even beyond the traditional economic system. Its versatility is being used for international trade, managing complex databases like healthcare records, and even energy grids.
What is Decentralized Finance (DeFi)?
DeFi is a type of financial system that uses blockchain technology to allow direct transactions between all parties. These transactions are made through smart contracts, which are self-executing applications on the blockchain that automate these operations.
The fact that everything is automated in DeFi can be seen as a huge benefit when compared to “analog” transactions. Once the code is sent to the blockchain, swapping assets is a lot quicker, anonymous, and decentralized.
How Does DeFi Work?
To better understand how DeFi works, let’s define some terms that you’ll encounter as you go along in your journey:
Blockchain
The blockchain is a giant decentralized public ledger capable of storing and inputting millions of commands every second. It doesn’t have one physical location but instead relies on a network of computers and servers that each validate every single transaction in the platform. Given this huge outreach, every transaction is public in the blockchain, making it a far more transparent alternative to traditional financial institutions.
Digital Wallets
Digital wallets are a type of software application capable of storing digital assets and communicating with blockchains. To execute a transaction on a blockchain, such as the Ethereum blockchain, users must send and confirm the transaction using their digital wallets.
Smart Contracts
Smart contracts are self-executing applications where the terms for each contract is input in the blockchain code. Every time a user sends, or swaps crypto, a smart contract is created in the blockchain to automate the process.
Nodes and Transaction Confirmation
Nodes and validators are one of the most important steps in DeFi as they make sure the transaction follows through safely in the blockchain. Have you ever noticed how every time you send or receive crypto, there are a couple of minutes of confirmation?
This delay happens because the blockchain is taking the time to validate the transaction with node confirmations. Once the transaction is validated by the majority of nodes, the transaction is recorded in the blockchain, becoming irreversible.
Consensus Mechanism
Different blockchains have different ways of validating a transaction. This process is known as the ‘consensus mechanism’, and it defines if a transaction should follow through through a series of processes.
Proof-of-work (PoW) is the most known consensus mechanism. Popularized by Bitcoin, this process requires miners to compete among themselves to solve complex mathematical problems. Once one of these problems is solved, the successful miner gets to add the next block to the blockchain and receive a reward, and by that confirming the request.
Most commonly, PoW is the node-confirmation mechanism that requires computers to solve hard mathematical equations in order to confirm each node. Other than that, there are also other types of consensus mechanisms like proof-of-stake (PoS), proof-of-history (PoH), and proof-of-authority (PoA). While these require different actions, they all do the same thing which is achieving consensus among nodes to maintain the integrity and security of the blockchain.
Key Features of DeFi
DeFi companies stand out against traditional finance firms due to some key features. For starters, everything is completely decentralized, meaning no centralized concentration of funds in the blockchain. It also is deemed more transparent than its counterpart due to the blockchain recording every transaction, making it publicly available.
DeFi is extremely accessible. Today, investors can access digital assets platforms anywhere in the world with internet connectivity. It is considered more interoperable as different platforms and services are able to work seamlessly together.
DeFi is also a key driver of innovation. Compared to traditional payment systems like SWIFT, DeFi's speed and scalability make it stand out. Its ongoing development and advancement have the potential to significantly transform the financial landscape and possibly overtake traditional systems in the future.
What is a DeFi Protocol?
A DeFi protocol is a set of rules and definitions that guide how an application works on the blockchain. In other words, DeFi protocols are the framework that guides the smart contracts in doing their job on the platform.
Most protocols are established under a 'token standard.' For example, Ethereum's blockchain uses the ERC-20 standard, which defines a framework for creating and managing tokens on the Ethereum network based on Ether.
The same is true for other Layer-1 blockchains like Solana, which uses the SPL (Solana Program Library) that functions as the ruler of the creation and activity of SOL-based tokens in the Solana ecosystem.
How to Get Started with DeFi
Dipping your toes in the vast world of DeFi may seem daunting at first, but once you learn the ins and outs of the market it can become an incredibly rewarding experience. The first step is to set up a digital wallet to store assets and interact with DeFi platforms.
After that, you need to buy digital assets like Ethereum, Bitcoin, or Polygon and transfer those to your chosen wallet. Once you’re up and running, you can start exploring the endless possibilities of DeFi in several different ways. For example, with Ka.app you can easily send, receive, and convert cryptocurrencies.
FAQs
Is DeFi safe?
DeFi is generally safe if you take the extra steps to provide the most security to your devices. Using VPNs can also provide more safety.
What is a DeFi wallet?
A DeFi wallet is the tool you use to control your digital assets. Wallets like the Ka.app digital wallet allow you to send, receive, and convert assets in the blockchain simply and safely.
How to transfer money from DeFi wallet to bank account?
To transfer money from your DeFi wallet to your bank account, you need to complete all the verification steps to confirm withdrawals. After that, all you need to do is to swap your assets for traditional currencies like the euro. Finally, send the converted funds to your bank account.
