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What is DeFi?

Posted September 13, 2022 4:07 pm
4 min
By Deep In The Sesh

For those of us unlucky enough to interact with traditional banks you’ll probably be familiar with the glacial pace that anything happens. Let’s say you want to file for a loan. You’ll fill out a form, meet with a bank manager wait a few weeks and maybe you’ll be approved. The whole process takes weeks and there’s no guarantee you’ll be approved. This is how the banking system has been for the last hundred years. 

Then in 2009 an amazing thing happened: Satoshi invented Bitcoin and the seeds of change were planted.  

Fast forward to today to the world of cryptocurrency, the word “DeFi” is being thrown around on CNBC and used in the Wall Street Journal. So what does it mean and how does it affect whether or not you’ll get a bank loan?

Let’s jump in.

DeFi: Explained

DeFi – pronounced dee-fye – is short for decentralized finance; according to popular crypto exchange, Coinbase, the term is considered an umbrella term for financial services on public blockchains using decentralized technology. Examples of blockchains that have DeFi activity include, Ethereum, Binance Smart Chain and Avalanche, to name a few.  

“With DeFi, you can do most of the things that banks support — earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and more — but it’s faster and doesn’t require paperwork or a third party,” the company explains. 

With that in mind, this industry operates in a peer-to-peer manner – meaning that it happens directly between two people or organizations without needing a centralized system or an intermediary, open to all, while operating on the blockchain. 

Learn: Blockchain is a database technology that allows transactions to be stored securely, as well as value to be held within this technology without a middleman because it is decentralized and peer-to-peer.

The DeFi ecosystem emerged in 2015 focusing on financial services. Developers built platforms where users can deposit, borrow, trade, and withdraw tokens. Currently there are three main uses for DeFi protocols: 

  • Banking services (i.e., issuance of stablecoins)
  • Peer-to-peer or pooled lending and borrowing platforms
  • Advanced financial instruments such as decentralized exchanges (DEX), derivatives and predictions markets

History of DeFi

While some industry experts argue that the birth of DeFi came with the inception of Bitcoin earlier in 2009, the turning point for financial applications allowing users to leverage the technology for more than just payment transactions came with the invention of the Ethereum blockchain in 2015. Ethereum paved the way for smart contracts which are at the heart of DeFi. Essentially its programmable money. Later in 2017, the DeFi movement started to take off with the introduction of MakerDAO and it’s stablecoin, Dai. 

“MakerDAO is an Ethereum-based protocol that allows users to issue a cryptocurrency that’s pegged at 1-to-1 to the value of the U.S. dollar by using digital assets as collateral. This mechanism effectively allowed anyone to borrow the Dai stablecoin against Ether (Ethereum’s native cryptocurrency),” an article by CoinMarketCap highlights. 

In parallel, the technology opened the door for anyone to take out a loan without relying on a centralized entity while also allowing the creation of a dollar-pegged digital asset. The act removed the shackles of holding dollars in a bank and replaced it with the freedom of stablecoins such as USDC and USDT.

This created a frictionless process to borrow and lend money. All you needed was to own cryptocurrency and you could borrow or lend with no restrictions and no waiting for a banks approval. 

Web3 Gaming

According to DeFi Pulse, a website that publishes metrics on the decentralized finance market, the Total Value Locked (TVL) on DeFi protocols reached $93 billion in early January 2022. However, what does this have to do with Web3 gaming?

To answer this, consider the famous Web3 game: Axie Infinity. In Axie, players earn rewards by playing with NFTs in the game. These rewards are often offered through a utility token that players can buy and sell on DeFi platforms. Without DeFi platforms, Web3 gaming would most likely not exist in its current form. There would not be the same frictionless market for buying and selling of the rewards token or NFTs. 

In summary, DeFi is leading the movement from centralized, opaque financial institutions to open, decentralized platforms which help democratize finance. This helps improve security, reduces friction and overall costs for financial consumers. Additionally, it is the grease that keeps blockchain projects, like Web3 games, working smoothly.

Disclaimer: The information provided on this page do not constitute investment advice, financial advice, trading advice, or any other sort of advice and you should not treat any of the website's content as such. Individuals should do their own research before taking any actions related to the product they read about and carry full responsibility for their decisions.