What is DeFi Crypto - Definition & Meaning

Decentralized finance, as opposed to traditional finance, is an emerging technology designed to reimagine money management and improve transparency. This type of investment and trading is based on transparent blockchain technology, and it’s entirely conducted without the control of central banks and other financial institutions.

If you want to know what is DeFi in cryptocurrency terms and how it works, we’ve put together a complete DeFi guide.

DeFi Definition

‘DeFi’ is the most commonly used abbreviation for decentralized finance, or in other words, a financial system that’s not under the control of banks and other financial institutions. Which has also been abbreviated to ‘TradFi’.

You might wonder what could be the benefits of investing in an unregulated DeFi token, but there are many.

For example, you can trade cryptocurrency without covering the banking and transfer fees you typically pay when trading stocks, commodities, etc. The new and emerging technology that makes decentralized finance possible aims to remove third parties from financial transactions while allowing holders to keep their tokens in secure online wallets.

In other words, when you invest in DeFi, you regain complete control over your investment at all times. You can buy, sell, trade, or invest in digital currencies whenever and wherever you want, as long as you have an internet connection. Needless to say that such an approach offers all kinds of short and long-term benefits we’ll get to in just a minute.

How Does DeFi Work

Now that you know the DeFi definition, it’s time to see how it works from up close. Unlike traditional finance, that’s completely centralized and controlled by banks; decentralized finance offers an open-source approach. As a result, it creates a system where all users can access various financial products without a middleman involved in the process.

Users can trade, borrow money, create savings accounts, and get any other traditional financial service without paying fees, even if they have low credit scores. Since the system is built on blockchain technology, it connects users directly, and smart contracts guarantee that every agreement is fulfilled.

The new, revolutionary approach to finance has increased the popularity of DeFi in the past few years. The DeFi market was worth $700 million at the beginning of 2020, but by the end of 2021, the market grew to a whopping $85 billion. According to this DeFi Market Cap prediction for 2023 and 2024, there is still plenty of room for growth.

The rising insecurities of the global markets have resulted in a massive shift as millions of investors move from traditional finance to a decentralized financial system. Smart contracts proved to be extremely useful for transferring assets, as they are computer programs that execute transactions automatically as soon as both parties agree to the trade.

There are no long waiting times, no additional requirements, credit scores, or anything else that could complicate the transaction. Blockchain technology makes it easy to track individual contracts, oversee policies in real-time, and it can apply to many other industries as well.

Why is DeFi Important For Crypto

That brings us to the next question – why is DeFi so important for crypto? You may not know this, but there are dozens of parties involved in every traditional financial transaction you make. For example, every time you store fiat currencies in a bank, the bank charges you a fee every time you want to transfer the money to a different account. Even though these fees are usually not that high, they can add to a hefty sum if you make transactions often.

However, if you use the best DeFi coins when transferring cryptos, you don’t have to worry about covering transfer fees or other expenses with traditional banking. DeFi trading is still a new trend, so it’s still largely unregulated by conventional financial institutions. It allows you to manage your money without communicating with a central bank.

You can make transactions without needing permission from the bank, and most transactions are instant. There are plenty of perks when investing in DeFi tokens, but you should be aware that privacy is not one of them.

We already stated that DeFi is built on blockchain technology, which means that all transactions are public. The increased transparency is what makes blockchain so popular in the financial world. It makes it easy to track every investment and ensure that your money is always where you want it to be. That’s what decentralized finance is supposed to do, and it does it without mistakes.

What Advantages DeFi Brings

We’re finally getting to the part everyone wants to know more about – the real benefits of joining decentralized finance. The truth is that DeFi can be used to reimagine all kinds of financial processes and help bring them to a new level. Here are some of the advantages you can enjoy when investing in DeFi.

1. Complete Control Over Your Finances

DeFi is becoming more and more popular primarily because it provides users with complete control over their finances. You don’t have to wait for permissions, pay transfer fees, or wait days for payment. That means that you can get loans, make money transfers, and enjoy most other financial services as long as you have a crypto wallet and access to the internet.

DeFi lending platforms are becoming increasingly popular which offer crypto interest accounts and the ability to take out crypto loans backed by your holdings.

2. Real-Time Transactions

Blockchain technology is built to allow instantaneous money transfers, which is something traditional financial systems can only dream about. Moreover, all details about every transaction and offers are updated in real-time, so there’s no guesswork involved.

3. Transparency

The Ethereum Blockchain, on which most of the DeFi tokens are built, is designed to provide users with 100% transparency. Over 90 of all traffic is publicly available and can be viewed and verified by any user.

4. Programmable Smart Contracts

Smart contracts are a truly revolutionary approach to finance. Users can program these contracts to act automatically and execute transactions without human intervention. That’s extremely useful for trading cryptocurrencies, as you can keep making a profit.

5. Open Source DeFi Protocols

Ethereum is the largest open-source blockchain project in the world, and it allows users to keep adding new features to build a better system. The approach led to a decentralized finance system in the first place. Developers from all over the world keep working hard to connect multiple DeFi applications to introduce new financial products and services to help users get the most out of their finances. It’s a win-win situation for everyone involved.

What Are The Shortcomings of DeFi

As mentioned earlier, DeFi is still relatively new, and as such, it does come with some shortcomings. While it provides users with countless benefits, it can also cause trouble if you’re not careful. Here are some of the risks of using DeFi to manage your finances.

1. Still an Emerging Technology

DeFi is still a new technology means that there are still many testing and regulation adoptions down the road. In addition, many DeFi platforms are still missing advanced security features and are prone to issues that could lose your investments.

2. Missing Consumer Protection

The absence of rules and regulations that attracts people to decentralized finance systems is also dangerous. Yes, users get more transparency and more accessible methods for transferring money, but they also have no control over security. If anything goes wrong, you won’t have anyone to help you get your investment back.

3. Cybersecurity Threat

Cybersecurity is always an issue when new technologies are introduced to the markets. Even traditional finance providers struggle to keep hackers at bay, let alone something still in its earliest stages. Unfortunately, the technology behind DeFi makes it a prime target for hackers. It has plenty of potential failure points, and there’s an entirely new group of hackers specializing in exploiting smart contracts.

4. Private Key Requirements

If you want to use DeFi features or trade crypto, you need secure crypto wallets where you can store your digital assets. Every wallet has a private key, which is a unique code known only to the user. If you lose the key code, you will get locked out of your account forever.

Applications of DeFi in Crypto

One example of how DeFi applies to crypto is decentralized exchanges (DEXes)- as opposed to centralized exchanges (such as Coinbase, Binance etc.)

DeFi Coin (DEFC) is the native token of a decentralized cryptocurrency exchange called DeFi Swap. With a similar utility to Uniswap (UNI), the native coin of UniSwap exchange.

The use case of a DEX is fully decentralized crypto swaps without the need of a middleman or broker having any control over your funds. Apart from swapping crypto to trade, users can also take advantage of DeFi yield farming – staking their DeFi tokens for an annual percentage yield, in the case of DEFC that’s up to 75% yearly.

DEFC is the governance token of the wider DeFi Swap project that also enables holders to have a say in the direction of the project and vote on proposals.

DEFC is also a tradable asset so crypto traders can profit from its price movements – in May 2022 it made an over 500% move to the upside. That then retraced to retest support when the crypto markets were shaken by one of the largest DeFi projects failing – Terra (LUNA) and TerraUSD (UST).

DEFC can also be a safe long-term investment due to the 75% APY possibilities.

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Conclusion

DeFi is an emerging financial trend that’s growing faster than anyone expected due to the rising financial insecurities all over the globe. It is becoming a favorite alternative to traditional finance systems because it’s transparent, fast, and provides more control.

Goldman Sachs have also mentioned in reports that DeFi has the ‘potential to disrupt the financial system’ i.e. shake it up and make it better, especially for underbanked populations around the world.

The technology behind DeFi is still in its earliest stages, so do your own research if you want to invest in DeFi, as there are some potential risks and problems you might face down the road. The LUNA crash and Celsius freezing assets showed that it’s important not to over-invest in one DeFi crypto project or lending platform – diversify your portfolio across a range of DeFi and yield farming platforms.

We hope that this beginner’s DeFi guide we’ve helped you answer the question of what does DeFi mean, and that the information we provided will help you make better decisions when investing in digital assets.