What Is Decentralized finance (DeFi), & Why It Is so Important?

In This Article, you can Learn What Is DeFi and DAO in the Detail are Given Below.

Decentralize Finance
Decentralize Finance

What is decentralized finance (Defi) & What is its use of it?

The cryptocurrency industry has grown into a trillion-dollar industry today, causing worldwide financial disruption.

In the 1980s, advances in cryptography led to the creation of the first cryptocurrency, Bitcoin. Since then, a series of events have shaped the space, with Bitcoin being the most prominent. Bitcoin has very slowly branched out into financial services despite its phenomenal growth in the past 12 years – primarily because of its inherent instability and lack of adoption. Due to the volatility of Bitcoin’s price, mainstream institutions won’t accept it as a loan – making Bitcoin a poor asset to use to plan investments.

Decentralized finance (Defi) is a current trend and a hot topic in the crypto space. If you’re not familiar with Defi, let’s take a closer look.

Decentralized finance (Defi) explained

Defi, which stands for decentralized finance, refers to a variety of applications in the public blockchain space designed to disrupt traditional financial systems. The DeFi term refers to financial applications built on blockchain technologies, usually using smart contracts. Smart contracts are automated enforceable contracts that can be accessed by anyone with an internet connection and can be executed without intermediaries.

A Defi is a network of applications and peer-to-peer protocols based on decentralized blockchain networks that facilitate easy lending, borrowing, and trading of financial tools. The vast majority of Defi applications today are built on the Ethereum network, but there are many other public networks emerging that offer superior speed, scalability, security, and lower costs.

What Is Privacy in Defi?

The best solution for bringing privacy to DeFi is native anonymity. That is, all blockchain transactions have to be opaque by default. That way, Main Street users get the privacy they require without having to take the risk of jumbling up their coins with crooks.

What is DAO and how does it work?

DAO stands for decentralized autonomous organization, which is a fancy term for a group of people who agree to abide by certain rules for a common purpose. Those rules are written into the code of the organization via smart contracts—algorithms that run when certain criteria are met.

What Is DeFi Game?

The term “DeFi” has been created by using two words – ‘decentralized’ and ‘finance’. As the name might hint, the games work without a central authority. All the game’s transactions get logged into a public blockchain. These games usually have a play-to-earn model and use NFTs to represent in-game items.

How did Defi get its start?

As humans developed, economies evolved. We invented currency so that we could exchange goods and services more easily. Subsequently, coins ushered in innovations and bolstered economies. However, progress comes at a price.

In the past, central authorities have issued currencies that fueled our economies, which gave them increasing power as more people trusted them. Yet, trust has been broken from time to time, which makes people doubt the ability of centralized authorities to manage money. The Defi project was designed to create a financial system that is open to all and minimizes the dependence on a central authority.

It is argued that Defi was born with the launch of Bitcoin in 2009, which was the first p2p digital money built on top of the blockchain network. Using Bitcoins to usher transformation into the traditional financial world is an essential next step in decentralizing legacy financial systems. In 2015, Ethereum and smart contracts, specifically, made all this possible. Ethereum is a second-generation blockchain that first made use of this technology within the financial industry. Defi encouraged businesses and enterprises to build and deploy projects that formed the ecosystem of Defi.

With Defi, there are many opportunities to create a transparent and robust financial system that is not controlled by one entity. However, 2017 marked the turning point for financial applications, with the advent of projects that provided additional functionalities beyond just money transfers. Financial markets can enable great ideas and result in greater prosperity for society, but power in these markets is centralized. The current financial system involves investors relinquishing their assets to intermediaries, such as banks and financial institutions – this keeps control and risk at the center.

As seen in the 2008 financial crisis, banks and institutions often fail to see risks emerging in the market. Undoubtedly, when central authorities control money, risks accumulate at the center and endanger the system. When it comes to issuance and storage, bitcoin and early cryptocurrencies, which were designed to give individuals complete control over their assets, were only decentralized. Up until the emergence of smart contracts and Defi, providing access to a broader set of financial instruments remained difficult.

Defi protocols and how they work

As a result, Defi has developed into an ecosystem of working applications and protocols that deliver value to millions of users. Assets worth over $30 billion are currently locked up in the Defi ecosystem, making it one of the fastest-growing segments within the public blockchain space. The following are the most popular Defi use cases and protocols available in the market today:

Defi lending and borrowing

Finance took a new turn when Defi enabled lending and borrowing. Widely regarded as ‘Open Finance,’ decentralized lending offered crypto holders the chance to gain annual returns. In decentralized borrowing, individuals can borrow money at a fixed interest rate. The aim of lending and borrowing is to serve financial service use cases while also satisfying the needs of the cryptocurrency community.

The top lending and borrowing platform for Defi borrowers: Compound Finance Launched in 2018, Compound Finance is the brainchild of Rober Leshner. The project involves developing a lending protocol on the Ethereum blockchain that allows users to gain interest by lending out assets or borrowing against collateral. By setting interest rates based on computer algorithms, the Compound protocol creates liquidity for cryptocurrencies.

How does Compound work?

The Compound protocol allows users to earn interest by depositing cryptocurrencies. Here is a list of the cryptocurrencies that can be deposited, along with the expected Annual Percentage Yield (APY). Users can use cryptocurrencies as collateral for loans once they are available on the Compound platform.

Compound token: $COMP

By holding $COMP tokens, holders can suggest and implement development changes to the Compound protocol. Examples of such changes are:

Select which digital assets to support. 

Modifying how $COMP tokens are distributed.

Collateralization factors are adjusted to the platform. Decentralized exchanges (DEx) are one of the main features of Defi, with the maximum amount of capital locked in comparison to other Defi protocols. Users can exchange or swap tokens with other assets without the need for a centralized intermediary or custodian. Traditional exchanges (centralized exchanges) offer similar options, but the investments offered are governed by the will of that exchange. Uniswap Founded in 2018 by Hayden Adams, UniSwap is the largest automated token exchange by trading volume deployed on the Ethereum blockchain. Another downside of CExs is transaction costs, which DExs address.

 UniSwap automated cryptocurrency transactions with smart contracts after receiving grants from several capital ventures, including the Ethereum Foundation.

How does it work?

At present, UniSwap offers three functionalities: swapping tokens, adding liquidity, and removing liquidity.

Swapping tokens

Users are required to create an account on Metamask to utilize this service.

Once a Metamask account is created, users can select tokens they own to swap for another type of cryptocurrency.

Adding liquidity

To provide liquidity, users deposit an equivalent value of tokens into the token’s associated exchange contract

Once you have tokens for liquidity, you can add them to a “pool” on the UniSwap interface.

Users who provide liquidity on UniSwap earn exchange fees, calculated per the value of tokens offered for liquidity.

Removing liquidity

You can remove the liquidity on UniSwap by merely choosing the ‘Remove Liquidity’ option from a drop-down menu.

UniSwap token: $UNI

$UNI is the governance token of UniSwap, meaning the token holders have a say in the protocol’s development and treasury. The token was launched in September of 2020 and was awarded to anyone who has used Uniswap.


Stablecoins are a viable solution to volatility issues surrounding cryptocurrencies and are helping Defi gain prominence. The name says it all — stable coins value is tied to a relatively stable asset, like gold or the US dollar, to keep its price consistent. Stablecoins became useful during risk-off moments in the crypto space, providing a safe haven to investors and traders. Stability makes them a reliable collateral asset. Stablecoins also play an important role in liquidity pools — an integral part of the Defi ecosystem and DExs.


Founded in 2015 by Rune Christensen, MakerDao is an organization building technology for savings, borrowing, lending, and a stable cryptocurrency on the Ethereum blockchain. The project was one of the earliest Defi protocols. Instead of conducting an ICO, the project privately sold $MKR tokens to fund the development over time. $DAI, Maker’s stablecoin, was launched in 2018 and has experienced significant traction.

How does MakerDAO work?

The protocol works like this:

A user can send or deposit $ETH to a smart contract on Maker’s protocol and create a Collateralized Debt Position (CDP). This will enable the ability to take $DAI at a specific collateralization rate.

Suppose the price of $ETH drops in the future. In that case, the CDP of a user will automatically be closed to ensure the network has enough capital locked against the borrowed tokens. This can be prevented by putting in more $ETH or taking out less DAI in the first place.

$ETH can be claimed back by paying back the amount, with the addition of a small fee.

Maker protocol tokens: $DAI and $MKR

The project requires two kinds of tokens to work: $DAI and $MKR

$DAI is created by locking a cryptocurrency in the Maker protocol. $DAI is used like any stablecoin: trade it against other digital assets or use it to make purchases.

Unlike $DAI, MakerDAO’s $MKR token is volatile and isn’t pegged to any asset. $MKR tokens are used in voting on proposals that affect how $DAI can be used. Holders of $MKR tokens are benefitted when the token increases — however when the system fails, they take the largest hit in price.

Prediction markets

Predictions markets are platforms where individuals can make predictions on the realization of future events, ranging from sports bettings or politics to predictions on stock prices and more. Defi opens these markets for participation. The concept of decentralized prediction markets has long been touted as a possibility through smart contracts.

Top prediction market: Augur

Augur is a decentralized prediction market platform that utilizes the collective prediction of the masses. The Defi platform August uses Ethereum to harness the “Wisdom of the Crowd” to create real-time predictive data. The first version of Augur was released in 2015 and its mainnet was released in 2018.

How does Augur work?

Augur offers you two primary actions:

Market creation: Users can create an Augur market by spending some amount of Ethereum. When creating a market, users need to set the taker fees and maker fees, which should be low enough to incentivize people to bid and high enough to cover the Ethereum cost.

Trading Events Shares: Users can buy or trade shares that represent the odds of the occurrence of a market event. Traders can make money by buying positions at a low cost and selling them when the price goes up. People who predict an event correctly will also receive rewards when the market closes.

Augur token: $REP (reputation token)

$REP is an ERC-20 token used on the Augur platform to create a prediction market, purchase participation tokens, or dispute an outcome. As the name suggests, $REP represents token holders’ reputation in the market. For any action that requires tokens, users stake their reputation.

Asset management

Another class of service offered by Defi is asset management. It intends to make investing faster, less expensive, and more democratized. Aspects of the Defi ecosystem play very favorably for Asset Management, including transparency, composability, and trustlessness.

Transparency promises to make information accessible and secure, composable to enjoy hyper-customization of portfolios, and trustless to allow access to historically illiquid assets and manage their investment regardless of location.


Launched in 2020 by Evan Kuo, Ampleforth aims to provide a non-collateralized digital asset that helps traders and investors diversify their crypto portfolios. Ampleforth is an asset-management protocol of Defi designed to be synthetic and smart commodity money. “Synthetic” because they’re created by humans but aren’t raw materials like gold.

How does it work?

Ampleforth adjusted its tokens’ supply daily to match the market demand using a smart contract. These smart contracts use Ampleforth’s and Chainlink‘s price oracle to get real-time data from Bitfinex Exchange and KuCoin Exchange. These decentralized price feeds help determine if the token’s price is within the equilibrium range (0.96-1.06 USD range). Suppose an $AMPL token price is lower than $0.96, the supply decreases. If it is greater than $1.06, Ampleforth increases the supply.

Ampleforth token: $AMPL

$AMPL is an ERC-20 token that seeks the price target of 1 US dollar. However, instead of pegging it to a fiat currency, Ampleforth allows the tokens to fluctuate in addition to price, as it seeks to achieve an equilibrium range. The price is adjusted automatically in Ampleforth wallets. Since the supply of $AMPL tokens remains unaffected during inflation or deflation, Ample is an ideal asset that can maintain its purchasing power against other assets.

The future of Defi

Decentralized finance or DeFi is a relatively new idea even in the fintech world, but it has been gaining traction over the past year. DeFi offers a different experience to traditional banking and opens up a world of possibilities previously closed to consumers.

We’re observing a quantum leap in the new possibilities of the functionalities of money through the innovation of distributed ledger technologies. For the first time in history, a global financial system for a worldwide population is being shaped by that very population. Everyone can take part in the governance of Defi protocols and get a seat at the table where the world of decentralized finance is actively created.

The Defi space is gradually catching up with the traditional financial system and despite some of the obstacles which are certain while operating on the bleeding edge of innovation, the world of decentralized finance is on the path to prosperity. Over time, it’s difficult to predict how this space will shape when the power to build financial services will democratize. However, at the point where Defi and fintech map and merge, we’ll have an inflection point where nascent financial technology is just part of a new financial system. One that realizes the dream of being fast, secure, available, and egalitarian.

Leave a Comment

Your email address will not be published.