What is DeFi?
- DeFi, short for decentralized finance, is a term for financial services that is based on peer-to-peer blockchain technology. DeFi generally works without any need of central authorities, such as banks or institutions, which makes it faster and easier to use than traditional finance since it is free from the influence of third parties.
Similarities and Differences Between DeFi/CeFi (web3 finance) and TradFi
- Type of service: both provide financial services, such as transferring money, and both are already integrated with application
- Medium of service: traditional web-based & mobile based application
- Centralization & Intermediary: Transactions in DeFi are done using smart contracts, which mean there are no intermediaries involved. While TradFi is centralized on central authorities and relies on it as the intermediary to facilitate transactions. DeFi therefore offers higher yield to market participants as the need to pay fee to intermediaries is eliminated.
- Regulatory: In TradFi, there is always a single regulatory body, like the SEC in the US, while in DeFi there are still no clear regulations and no specific institution that regulates it.
- Custodian/brokerage: DeFi is non-custodial which means the custody of banking information and personal data is in the user, while TradFi is custodial and requires the user to provide personal data. This makes DeFi more secure than TradFi.
- Accessibility: Another difference between the two is in accessibility. TradFi tends to be more restricted, since it is regulated by authorities, and hard to access. On the other hand, DeFi is more accessible and open, since there are no special requirements imposed by third parties to users.
Different Types of DeFi
- There are many types of DeFi, some of the more well known ones are Automated Market Maker (AMM), Borrowing and Lending, DeFi Aggregators, and many more. These services usually can be accessed through DApps, short for decentralized applications, and are implemented through blockchain and smart contracts.
Automated Market Maker
- Automated Market Maker is a DeFi service that allows digital assets to be traded automatically and without permission using smart contracts instead of with other people. With automated market maker, there is no need to search for buyers or sellers, since every transaction is done by using liquidity pools.
- Some examples of automated market makers are Uniswap and Pancakeswap.
Borrowing and Lending
- Borrowing and lending in DeFi is practically done the same as borrowing and lending in TradFi, except it is done in a decentralized environment. This means that while the act of borrowing and lending is the same, the requirements for it are less than the one in TradFi. By going through smart contracts, borrowers and lenders do not need to give personal information to third parties before they can deposit or borrow.
- Some examples of borrowing and lending platforms are AAVE and Compound.
- DeFi aggregators are DeFi services that don’t have their own product, but synthesize the information from other products to make DeFi more simplistic. Since DeFi is implemented on blockchains, sometimes searching and gathering information can be time consuming since you will need to access different platforms and blockchains. DeFi aggregators collect this information in one place, and then select the best prices to show the users which is more convenient and efficient than the traditional way of manually checking each platform.
- One of the most well known DeFi aggregators is 1inch.
- DeFi also has many other products, like decentralized perpetuals which lets you long or short through smart contracts, decentralized options vault which lets you automate your trading strategy, and indirect investment through cryptocurrency.
- Examples of the products are: Synthetix, dYdX, and Ribbon.