Decentralized Finance (or simply DeFi) refers to an ecosystem of financial applications that are built on top of blockchain networks.

More specifically, the term Decentralized Finance may refer to a movement that aims to create an open-source, permissionless, and transparent financial service ecosystem that is available to everyone and operates without any central authority. The users would maintain full control over their assets and interact with this ecosystem through peer-to-peer (P2P), decentralized applications (dapps).

What are the main advantages of DeFi?

Traditional finance relies on institutions such as banks to act as intermediaries, and courts to provide arbitration.

DeFi applications do not need any intermediaries or arbitrators. The code specifies the resolution of every possible dispute, and the users maintain control over their funds at all times. This reduces the costs associated with providing and using these products and allows for a more frictionless financial system.

Another significant advantage of such an open ecosystem is the ease of access for individuals who otherwise wouldn’t have access to any financial services. Since the traditional financial system relies on the intermediaries making a profit, their services are typically absent from locations with low-income communities. However, with DeFi, the costs are significantly reduced, and low-income individuals can also benefit from a broader range of financial services.

DeFi loans are gaining popularity along with other decentralized types of applications. Thanks to DeFi, anyone can now take out a loan of any size without having to disclose their identity to a third party. How do such platforms work and what does the future hold for them? Let’s figure it out.

How DeFi loans work

Most often, DeFi lending providers issue loans in stablecoins such as DAI or USDC. Cryptocurrency is the main collateral. All checks are provided through smart contracts. All the user needs is to link his wallet to the selected DeFi loans platform. Then the user pledges a certain amount of cryptocurrencies as collateral and receives a loan.

DeFi brings many benefits to users. For example, they don’t require identity verification. Plus, users can receive loans almost instantly thanks to automated smart contracts.

The future of DeFi loans

DeFi loans are one of the most promising areas in the crypto ecosystem. Compared to traditional loans, DeFi has several advantages such as

  • higher interest rates
  • permissionless
  • transparent in fund movements

However, there are also weaknesses here. For example, not all users are well-versed in the technologies and peculiarities of working with cryptocurrencies. Also, since the assets used in DeFi are volatile, there are always risks involved. But companies are working on it. Now DeFi looks like a promising analog of centralized financial systems.

What Does Decentralized Finance Do?

The goal of DeFi is to get rid of the third parties that are involved in all financial transactions.

Is Bitcoin a Decentralized Finance?

Bitcoin is a cryptocurrency. DeFi is being designed to use cryptocurrency in its ecosystem, so Bitcoin isn’t DeFi as much as it is a part of it.14

What Is Total Value Locked in DeFi?

Total value locked (TVL) is the sum of all cryptocurrencies staked, loaned, deposited in a pool, or used for other financial actions across all of DeFi. It can also represent the sum of specific cryptocurrencies used for financial activities, such as ether or bitcoin.15

Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.

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