What is DeFi and How Does it Work?

The existing traditional financial setup is centralized as it is governed by bodies like banks and central governments. Due to centralization, the traditional financial system is inefficient and exposed to risks like hacking. This brings in both financial and data risk to the users of the traditional banking system.

On the other hand, Decentralized Finance or DeFi runs on blockchain and brings improvements like permissionless setup, transparency, and decentralization. This is much different from the open banking system. While open banking draws data from several banks and institutions, it allows the management of traditional financial instruments using one application in a secure manner. On the contrary, DeFi allows the creation of entirely new financial instruments with which the users can interact in new ways. DeFi development has become increasingly popular. Businesses are developing DeFi apps that allow permissionless lending and borrowing funds. Additionally, liquidity providers can earn interest, provide risk coverage for insurance, and many other use cases. DeFi enables the execution of any financial transaction directly between participants. These transactions are mediated using smart contracts.

What kind of infrastructure support does a DeFi ecosystem require?

 DeFi Tokens
These tokens are the backbone of a decentralized ecosystem. They have different use cases like exchange of value, trading, governance rights, payment, investment, and more. The users of the platform might receive free tokens to provide liquidity to the DeFi platform or they might enjoy lower interest rates or transaction fee discounts. Some of the popular DeFi protocols that offer tokens to the platform users are Compound, Aave, and MakerDAO. The key idea behind the development of these tokens is to recreate the traditional financial services but in a permissionless and trustless manner.

 DeFi Lending/Borrowing Platform

DeFi lending platforms are the ones that lead the space right now. That’s because they have democratized the playground of both the banked and unbanked users. These platforms provide quick access to loans as opposed to the traditional lending system that is highly inefficient. It is a completely automated process where no central body can intervene and platform users enjoy equal lending and borrowing rights and opportunities. Basically, the
lending/borrowing process is controlled by a smart contract.

A Defi development company can help introduce some of the market-leading features to a DeFi lending/borrowing platform. These are flash loans, rate switching, limitless loans, fiat support, yield farming, and more.

 DeFi Wallet

A DeFi wallet supports the holding and exchange of DeFi tokens between the platform users. By leveraging DeFi development services, businesses can build a DeFi wallet that allows users to gain complete control of their assets as these wallets are non-custodial in nature. Along with that, these are designed to be immune to hacks  and follow stringent security protocols.

 DeFi Smart contracts

Smart contracts are predefined pieces of code that are autonomous in nature. These can be designed to automatically carry out transactions like fund transfers, settling agreements, and more without the intervention of any third party. At the time of building a smart contract, the terms and conditions are coded and audited. Once the conditions are met, the smart contract gets executed and the corresponding actions are carried out.

 DeFi dApps

DeFi runs on Decentralized Applications (dApps) or protocols. These dApps run on blockchain and provide the infrastructure to run a peer-to-peer financial network. These dApps can be combined with each other to run an entire financial setup.

 DeFi Exchange

DeFi Exchanges are built with smart contracts and integrated with cryptocurrency wallets. These exchanges are decentralized in nature and automatically match the buyers and sellers. When the DEX user places a buy or sell order on the platform, information like the number of units, price of tokens, and the time limit of token availability are integrated into smart contracts. Once the time of the order expires, the bids are reviewed and executed using smart contracts.

Wrapping it up

The future of decentralized finance looks very bright. Many institutions and enterprises have already started replacing their existing traditional setup with decentralized finance infrastructure. DeFi is expected to become more mainstream in 2021 and is not something that should be missed out on. Having developed top-notch DeFi protocols, applications, and exchanges, we understand the space well to support an end to end development of a DeFi ecosystem. We offer comprehensive DeFi development solutions – including DeFi token, DeFi wallet, DeFi
exchange, DeFi banking, and more. Connect with our subject matter experts to share your business needs.