Crypto Basics

What is DeFi? How Does It Work?

  • 05 Dec, 2022

  • 3 Min read

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DeFi, short for decentralized finance, are blockchain-based systems designed to replace or complement traditional financial services. Rather than relying on banks and other corporate institutions to provide services like loans and high-yield savings accounts, DeFi protocols enlist the help of decentralized computer networks, funded and secured by users across the globe.

What is DeFi?

Blockchain technology allows for trustless transactions between parties, and DeFi takes advantage of this to create value systems that mirror banking services. Dapps, or decentralized applications, can be built to leverage smart contracts to offer similar services. Smart contracts are computer programs that automatically execute logical tasks on the blockchain once certain conditions are met.

It’s estimated that nearly 2 billion people worldwide do not have access to banking services or the global financial system at large. Even in 1st world countries like the United States, nearly 5% of the population was considered “unbanked” as of 2021. DeFi services allow for anyone with an internet connection to take advantage of products such as:

→ Lending & Borrowing

→ Savings & Yield Products

→ Insurance

→ Asset Swaps & Exchanges

How does DeFi work?

In DeFi, you don’t need accounts, credit history, or even an ID. These protocols are made available for anyone to take advantage of — all you need is cryptocurrency. 

The key to DeFi is its peer-to-peer nature. By removing the middleman you remove time, cost and trust from the process of sending, receiving, lending, insuring and more. Transactions that take days or weeks with banks are settled in minutes for pennies on the dollar. Instead of leaving your money with an institution to loan out and monetize as they please, you keep control of your funds and can withdraw at any time. Banks are only open during work hours, DeFi is open 24/7/365.

While setting up a new financial system based around code and not institutions may seem far-fetched, the DeFi space had nearly $200B of value locked in smart contracts in 2022. Because these protocols are open-source, anyone can examine the code for themselves and decide whether the system will work as intended and as they desire. By simply connecting a wallet to the DeFi protocol of your choice, users can deposit and withdraw funds in and out of a smart contract to fulfill their banking needs in a decentralized manner.

What is a DeFi token?

All decentralized crypto protocols use tokens. Many of these are “governance” tokens,  or tokens that allow holders to govern whatever network it belongs to. For example, UNI and AAVE are governance tokens for the Uniswap and Aave platforms, respectively. Holders of these tokens can vote on proposed changes to the protocols and have a say in its direction and mission.

How to invest in DeFi

Before investing in DeFi, make sure to do your research and understand the protocol and tokens you’re investing in. Some good websites to examine different DeFi protocols are DefiLlama, DeFiPulse, and DappRadar. Once you know what token you’re looking for, you can start looking into exchanges that carry it.

Fortunately, DeFi tokens do not need to be purchased exclusively on decentralized exchanges. Uphold.com is a great place to buy DeFi tokens like UNI, AAVE, COMP, BNT, MKR, SUSHI, LINK and more.

Greg Lunt photo
Written by
  • Crypto Expert

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Greg Lunt photo
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  • Crypto Expert

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