Decentralized Finance (DeFi): Definition, How it Works – Business Insider

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DeFi has been called the “wild west” of the cryptocurrency world. It’s an unregulated financial system that many believe will revolutionize the way we conduct financial transactions.
But because it’s still largely unregulated, investors generally don’t have the same protections they do in traditional financial markets. In spite of the risks, the possibilities enabled by DeFi make it a very exciting space for crypto investors.  
Decentralized finance or DeFi is a global financial system that’s available on blockchains that are public — most often Ethereum
“DeFi stands for decentralized finance. In simple words it stands for self-custody finance. Unlike traditional finance where a company, bank, fund is responsible for your money, in DeFi no one but you has access to it,” explains Anton Mozgovoy, co-founder of Mover, a DeFi Savings platform.
Through this new emerging technology, DeFi expands what’s possible with cryptocurrency and moves beyond just currency and creates sophisticated systems with an abundance of uses with the creation of applications, typically referred to as decentralized apps, or dApps, which we’ll get into later.   
DeFi was coined in 2018 by a group of entrepreneurs and Ethereum developers who wanted to open up finance applications from traditional systems. The abbreviation sounds like defy, which is intentional.
DeFi, previously referred to as “open finance,” takes out the middleman in financial transactions. So instead of having your bank or credit card issuer be the intermediary between you and a merchant when you make a purchase, you use the digital currency and have ownership of it to use directly. DeFi is primarily based on Ethereum, the top cryptocurrency next to Bitcoin.
Here are the main tenets of DeFi: 
Though DeFi is usually a main player in the cryptocurrency conversation, it goes beyond creating an alternative digital currency or value. DeFi works to replace the role of traditional financial systems through its smart contracts. 
“DeFi is all about code. With the help of things called smart contracts, your money is programmed to perform various [functions]. It creates a unique opportunity for anyone with a computer and internet connection to participate in the global economy,” notes Mozgovoy.
One of the most attractive parts of DeFi for people is that it eliminates the barrier to entry for many of these financial transactions. You no longer have a government or corporation manage your money or need to qualify for certain financial products. 
Using traditional financial systems, you apply for a loan and may be rejected based on your credit. You have a bank account or investment brokerage with a company that oversees your money. 
With DeFi’s smart contracts, certain financial transactions are executed after specific conditions are met. The smart contracts allow for borrowing, lending, and more and the terms of the transaction are literally written in the code. While that makes these transactions easy-to-use and more efficient, it can also make them more susceptible to errors that can’t be fixed. 
Because of these smart contracts and the ability for Ethereum to create applications, DeFi can be used:
There are certain DeFi “building blocks” that create a software stack, with every layer building upon another. These layers work together to create DeFi and its related applications that serve users in a variety of different ways. If one layer is off, so are the other layers. 
The five layers that make up DeFi include:
The rising popularity of DeFi and other cryptocurrency make it seem like an attractive investment. But it’s important to understand what you’re getting into before taking the plunge, and understand the benefits and drawbacks. 
“In DeFi you hold your money, you control where your money goes and how it’s spent. DeFi is efficient, since everything is programmable, in a click of a button you can perform complex transactions,” explains Mozgovoy.
The accessibility factor can remove some barriers, but there are a number of cons to be aware of. 
“DeFi is new and experimental. Since everything is code, it can have bugs. Bugs lead to money loss or hacks. DeFi is new and complicated,” says Mozgovoy. “User experience can still be rough. Learning curve is still steep, but it will change.” 
There is no intermediary between transactions 
If you forget your password, you can lose your assets since there is no governing body
May offer more accessibility for loans and insurance without a credit score 
Lack of consumer protections 
May offer higher interest rates
High volatility and risk 
All investing comes with some level of risk and DeFi is no different. But any cryptocurrency or DeFi application may have a higher level of risk due to difficulties with regulation (though the SEC is looking to fix that) and potential scams. A good rule of thumb is to not invest any money you can’t afford to lose.
If you’re interested in investing in DeFi, there are a number of ways to do it. 
“To start in DeFi you need native currencies — like ETH, AVAX, BNB, FTM, MATIC and others — as every transaction will require gas. You can purchase those through various exchanges, wallets, and crypto services,” explains Mozgovoy.
You can start with a decentralized exchange (DEX) such as Uniswap. According to their site, you can “Swap, earn, and build on the leading decentralized crypto trading protocol.”
It’s important to keep in mind that since everything is relatively new with DeFi and there is no governing body, be careful about what you invest in. 
“In DeFi anyone can launch their own project, token, contract — that is why you should be aware of scams and low quality projects,” notes Mozgovoy. Aside from being aware of scams, in practicality, Mozgovoy states that with DeFi users can save, lend, or take part in derivatives and exchanges.
Quick tip: Read about Proof of Stake, which is used as a way to confirm crypto transactions, and what it means here.
DeFi is an expansive financial ecosystem that strives to take out the middleman and allow for financial transactions between users. Currently, there is a lot of hype around DeFi and crypto. If you want to take part, be sure to understand not only the rewards but also the risks before getting started.


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