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The appeal of blockchain technology and cryptocurrency has grown exponentially over the past decade, and DEFI is undoubtedly one of the chief factors behind its popularity. However, it is a term that is commonly misunderstood by new and experienced users alike. This simple guide will provide the answers to all of your key questions, including;

  • What does DEFI stand for?
  • What is DEFI in blockchain?
  • Where is DEFI found?
  • And more.

What does DEFI stand for?

DEFI, often written as DeFi, stands for Decentralized Finance. In its most basic definition, it is an umbrella term covering a range of financial products that become available on the public blockchain network in a decentralized fashion.

Many contributing factors separate DEFI from other financial instruments, but the most telling feature is that it offers peer-to-peer finance. This removes the intermediaries seen in more traditional environments, avoiding the need for banks, brokers, or agents. Instead, blockchain utilizes smart contracts that automate agreements to enable transactions directly between the sender and recipient or buyer and seller.

Additional features of the decentralized finance structure include;

  • No need for ID verification and proof of address.
  • Anyone can audit transactions, meaning greater transparency and trust.
  • DEFI transactions have unique blockchain addresses to remove privacy issues.
  • The whole process is automated, meaning instant transactions.
  • Systems automatically check addresses, thus eliminating errors.

DEFI is still a relatively new concept but has quickly gained popularity due to those key features. The speed of growth is underlined by the fact that the market cap of DEFI tokens is already more than 70 billion USD.

What is DEFI used for?

DEFI and smart contracts can be used in a wide range of financial transactions. However, decentralized exchanges, otherwise known as DEXs, are the most common by far.

DEXs are primarily thought of in the realm of digital currencies and cryptocurrencies. The peer-to-peer exchanges allow users to send and receive tokens like Bitcoin and Ethereum’s ERC20. However, it is also possible to exchange different digital coins or even complete exchanges with physical currencies like USD.

Other popular purposes of DEFI include, but are not limited to;

  • Lending platforms that opt for smart contracts rather than relying on intermediaries and the complexities that they bring to the table.
  • Prediction markets where investors ‘bet’ on the outcome of elections and other events of interest.
  • Yield farming, where traders look for opportunities stemming from alternative DEFI tokens on the market.
  • Composing new financial apps using DEFI frameworks but with public coding that others can view.

The DEFI industry is still focused on cryptocurrency and exchanges. Still, a host of additional opportunities (some linked, others not) have surfaced on the back of its growth and widespread implementation.

How does DEFI work?

All financial transactions, including traditional bank transactions, rely heavily on the presence of tech. However, rather than using tech to simply facilitate transactions, DEFI uses tech as the catalyst for all actions.

As a decentralized protocol, it is immune to the interdependency of different markets in key cities, which can help it avoid the impacts of recessions and similar situations. The technology builds a robust financial ecosystem, whether using public blockchains to replicate what’s already available or introducing custom-made services.

DEFI is utilized through software stacks, also known as DEFI stacks. They are made up of four layers;

  • Settlement layer - the base layer (Layer 0) that has a public blockchain and a native cryptocurrency. The digital token is subsequently used for settling the transactions and exchanges. Tokens can also represent physical currencies or physical assets as a symbol of ownership.
  • Protocol layer - the protocol layer sets out the rules and principles. Several developers or entities may use them to build a service. Protocol layers may also be used to build synthetic representations of physical assets.
  • Application layer - this is the component of a DEFI that is the public-facing layer. The most common examples are cryptocurrency exchanges and lending services. However, other decentralized applications can be found here.
  • Aggregation layer - this final layer has the aggregators that allow transfers of money between different financial instruments without delays or hold-ups. Crypto wallets and lending money are two good examples of this in action.

DEFI offers a decentralized and automated approach to financial transactions using a range of digital assets from cryptocurrency coins to other virtual tokens when the four layers are in place.

Where is DEFI heading?

Anyone searching what DEFI is in blockchain will soon realize that it is the technology that allows for smooth, decentralized, and permissionless applications that are instantly made global. It is already one of the most relevant developments in the finance sector, not only in relation to digital matters.

Given the fact that many aspects of our lives have shifted to the digital arena in recent times, it can be assumed that finance will continue to do the same. After all, it is a central feature of making the world turn while exchanges, borrowing, lending, insurance, and custody have already moved into this environment.

Accessibility of DEFI, particularly at the consumer-facing level, is set to be one of the key developments. This has already started with a host of DEFI features like Augur, PoolTogether, and Uniswap. Further user-friendly features are sure to enter the market as universal appeal continues to grow. Blockchain is no longer a resource used solely by tech experts and enthusiasts.

A DEFI ecosystem could essentially become the dashboard of all finances, with traditional financial institutes stepping into the environment too. If it did, it could potentially show users what assets are held at any given time, as well as their loans, credit agreements, and more.

The sky is truly the limit for DEFI technology and the blockchain. Mastering its potential in current situations by using it for sending and receiving tokens won’t just put you in a stronger position today. It will establish the foundation for those crucial moments to come over the coming years.

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