ELI5: Decentralised Finance (DeFi)
Tags: blockchain, eli5, defi, ethereum
Published: 2023-11-10 17:25:50

###HISTORY

The term DeFi pronounced as “De-Fy”, is the short word for "decentralised finance". It technically came into use in August 2018 during a _Telegram_ chat between Ethereum developers and entrepreneurs including Inje Yeo of Set Protocol, Blake Henderson of 0x and Brendan Forster of Dharma to denote an ecosystem of trustless and decentralized range of financial services being built on the Ethereum Blockchain. On November 9th 2021, the DeFi ecosystem hit an estimated Market Capitalisation of $173,612,419,950. By December 2nd 2021, its Total Value Locked was estimated at $182.93b with over 4m+ Users based on unique addresses.


###WHY DEFI?

DeFi leverages existing blockchain technology into a decentralized micropayment platform without any intermediaries. DeFi is one of the technological concepts which has huge requirements from the banking sector as well as from those who deal with a large number of financial transactions. The most promising feature provided by blockchain technology for DeFi is a smart contract system. This system acts as a virtual medium between the two customers directly. One can send any large or small amount to another customer by calling a transfer function of this smart contract feature.

###BANKS VS DEFI

The main problem with the current banking transactions is that it takes time to send money
globally and also it charges a customer service fee for every single transaction, which isn’t acceptable for all customers. Though the transaction fee for a big amount is acceptable, it isn’t that feasible for those who transfer small amounts.
The current banking system also puts a bar on the minimum amount a customer can transfer which makes the current banking system all more narrow. DeFi instead enables a user to make instant transactions globally within seconds without the need for a 3rd-party, through the use of a bunch of pseudo-codes.

###KEY TERMINOLOGIES IN DEFI

**1. Decentralised Application (DApp)**: DeFi runs on decentralised applications (DApps). These applications are distributed open-source software that runs on a peer-to-peer blockchain network. They basically provide a user interface to interact with the blockchain.

**2. Total Value Locked (TVL)**: TVL basically denotes the total value of the assets staked in the smart contracts of a DeFi platform. It works as an indicator of the funds available throughout different DeFi platforms for transactional, borrowing, and lending capacities.

**3. Automated Market Maker (AMM)**: An AMM is a decentralised asset trading pool that enables market participants to buy or sell cryptocurrencies. Uniswap is the first and most well-known AMM.

**4. Liquidity Pool (LP)**: An LP is a pool of deposited funds meant to provide liquidity to a currency, network, or Smart Contract. There are
usually designed rewards or incentives given to those who provide liquidity to pools.

###FEATURES OF DEFI

**- Transparency**: DeFi ensures that the process of every transaction is transparent. Hence, the distributed ledger contains information about all activities on
the blockchain network.

**- Permissionless**: With DeFi, you do not need the permission of any intermediary to carry out financial transactions. This takes away the pressure of over-dependence on centralised institutions.

**- Ease of Access**: DeFi provides quick access to the market and other financial transactions from any part of the world, all that is needed is an internet connection.

**- Traceability**: DeFi has a proper audit trail that makes it easy to identify the parties that made changes to a transaction, how the change was done and at what point it was done.

**- Immutability**: The utilization of cryptography and consensus algorithms make DeFi immutable. This means that it is impossible to manipulate any record on the blockchain.

**- Efficiency**: With the use of smart contracts under DeFi, human errors and mismanagements by third-party intermediaries and central banks are eliminated from the financial process.

###CONCLUSION

DeFi bridges the gap between the banked and the unbanked. Millions of people around the globe who do not meet the requirements for opening a bank account do not usually have access to traditional banking. However, with DeFi there are no distinctions, and it allows anyone with an internet connection to access financial services conveniently.