The landing of decentralized finance
DeFi is the English abbreviation for decentralized finance -decentralized finance- and is used to name a financial ecosystem built on blockchain technology. Its main characteristic lies in the fact that it is the users themselves who exchange (supply and demand) assets and financial services directly among themselves, without intermediaries, to use them as an investment or financing mechanism, for example.
How does DeFi work?
To understand how decentralized finance works, you must first understand the environment in which they operate. As we have already said, they use blockchain or ‘chain of blocks’, which consists of a network of participants connected to each other without the need for a central server and that is capable of transferring data and assets in a completely secure way and under the surveillance of the users themselves. In addition, DeFi operations are governed by smart contracts (intelligent contracts, in English), which are computer programs that also work with blockchain and that are executed automatically as the parameters that the parties involved establish in advance are met.
In other words, decentralized finance uses blockchain technology to store and transfer assets digitally, ensuring compliance with agreements by all participants thanks to smart contracts.
What are DeFi for?
Taking into account that the concept of decentralized finance is still very recent, both its potential and the uses that can be given to it will depend largely on what the users themselves demand, in addition to the regulations that can be implemented in the future. At the moment, there are already individuals and companies that are investing and financing each other using DeFi applications as a bridge to connect supply with demand, and using blockchain as a guarantee of security for transactions.
What is needed to use DeFi?
Virtually anyone with Internet access can be part of this financial ecosystem and can even create and offer services, such as loans, or evolve and combine other existing services thanks to the fact that DeFi applications are built with open source, that is, that its software or computer system is available to the public to be used free of charge and even copied, improved or adapted according to the needs of each case.
To access decentralized finance applications, it is necessary to have a virtual purse or wallet in which the tokens -interchangeable digital assets- are deposited, which is the ‘exchange currency’ used to operate in blockchain technology, and which can also be bought initially with legal tender money such as the euro, dollar, etc.
An example of the use of a DeFi application is that of a user who programs a smart contract to sell a number of tokens, such as cryptocurrencies, when they reach a specific price, seeking profitability. There is also the case of the user who wants to buy and prepares the smart contract to make the purchase automatically when said tokens are at the desired value. In both cases, the operations are executed automatically and without the intermediation of a third party, thus giving rise to decentralized financial agreements.
Things to keep in mind about DeFi
As we have seen, being a decentralized financial ecosystem, it lacks regulations by third parties. While in the traditional financial system it is possible to verify the identity and information of a person to evaluate aspects such as the debt profile when granting a loan, for example, in blockchain technology the identity is a public key, but that is not says nothing about the person behind. This lack of identification hinders aspects such as the prevention of crimes or tax fraud, among others.
Another factor to take into account is related to the security of financial assets, since in DeFi platforms it is the users who are in charge of guarding their own assets through access and authentication keys to enter financial applications. This means that they do not have the support of any entity that can provide or restore said information in the event of loss or theft, which causes the total loss of the assets.