Decentralized finance, which is often referred to as DeFi, is a peer-to-peer (P2P) financial system which is different from the traditional centralized financial systems. DeFi is usually facilitated by decentralized technologies that are built on distributed blockchains. With DeFi, a large network of financial instruments and integrated protocols have been launched, which enable people to use financial services more openly. The need for DeFi arose because the current financial system failed to provide credibility and financial freedom to the users.
DeFi is generally built on top of a blockchain in the form of a cluster or second layer applications. The blockchain makes up the general infrastructure layer. With this, DeFi inherits the important property of decentralization. However, this only holds if the blockchain itself is decentralized.
Benefits of DeFi
The core property of centralization in DeFi not only allows resistance against censorship, but also allows global users to participate regardless of their social status. It also provides trusted third parties.
Utilizing the technological infrastructure of blockchain makes way for speedy and low-cost transactions/settlements and also allows the immutability of financial contracts besides contract automation.
DeFi applications work in a way that allows users to be in possession of the private keys, which is referred to as non-custodial in a blockchain ecosystem. This gives full control of the money to the user without the need for a trusted third party.
DeFi makes way for better ecosystem transparency, which results in price and market efficiency. The principal-agent risks are close to none, because the asymmetric information is non-existent. The personal interests are mostly governed by a transparent protocol.