First, what is decentralized finance? It’s not as confusing as it sounds.
Simply put: DeFi platforms offer financial services without the need for banks or other centralized institutions.
But how? Well, instead of a bank or financial institution in the middle of a transaction, DeFi uses smart contracts (a computer program on a blockchain) to manage transactions.
Some established examples of DeFi are:
- Lending and borrowing: A technical term for a decentralized lending platform is a “liquidity protocol,” which is a fancy way of saying a place where many people deposit assets so that others may borrow them. Depositors provide liquidity and can earn interest when borrowers take out loans.
- Trading: There are various trading platforms like exchanges that allow for the simple exchange of crypto assets to more advanced DeFi trading services including derivatives of real-world assets.
- Staking: You can think of staking sort of like a high-yield savings account or a bank CD but without the consumer protection of a traditional bank account. When crypto is staked–meaning the deposit is locked–for a period of time, it allows users to earn rewards similar to earning interest.
Why invest in decentralized finance?
There are risks to investing in DeFi as even established platforms are relatively untested compared to the traditional financial system. But we are seeing further adoption of DeFi services including institutional activity from large banks. That may sound surprising but it could be seen as a sign that DeFi is maturing and on its way to a more mainstream audience.
Aside from its growth potential, DeFi may be an attractive investment if you believe in its broader purpose. DeFi has the potential to provide wider access to financial services across the globe and decrease transaction times (and hopefully costs) for consumers as it strips away some of the third parties that take profits.