What is Decentralised Finance (DeFi)
Today, almost every aspect of banking, lending, trading and the flow of money is managed by centralised systems, different country standards and operated by governing regulators. Regular bank customers need to navigate through middlemen and processes to get access to everything from car loans, mortgages to trading stocks and bonds.Regulatory bodies in the U.S, like the Federal Reserve and Securities and Exchange Commission (SEC), and in Australia, is the Australian Securities and Investments Commission (ASIC), set the rules for the world of centralised financial institutions and brokerages.As a result, there are few paths for a person to access capital and financial services directly. They cannot bypass middlemen like banks, exchanges and lenders, who earn a percentage of every financial and banking transaction as profit.DeFi challenges this centralized financial system by allowing anyone to borrow, lend and trade with each other without any interference from a third party such as a bank via peer-to-peer exchanges.
DeFi (Decentralised Finance)
A simple answer to what is a decentralised finance definition (DeFi) is that, it uses technology to enable the provision of financial services built on public blockchain. It is accessible digitally and it is the opposite of the current centralised ecosystem of the finance system. More specifically, the term Decentralized Finance refer to a movement that aims to create an open-source, permissionless, and transparent financial service ecosystem that is available anyway for everyone and operates without any central authority. The components of open finance consists of protocols, digital assets, dApps (decentralized applications) and smart contracts , which are built on Blockchain.
Why DeFi?
The intent behind the introduction of this new financial ecosystem is simple: It is to help the unbanked people in the world who lack basic financial service access due to ethnicity, age or cultural identity. Secondly, introducing open banking through decentralisation. This introduction and inclusion of decentralized financial technologies would mean that there is no point of failure for identical records that have been kept across multiple computers through peer-to-peer networks. Since it is permissionless thus, it is accessible and open to everyone.
What are the components of Defi?
There are four main components of DeFi; namely, Blockchain, Asset Layer, Protocol Layer or Smart Contracts and Digital Application (DApps). These components work together to provide users with easy access to financial products and services.
Blockchain
This is the foundation layer consists of the blockchain and its native protocol asset (e.g. Bitcoin (BTC) on the Bitcoin blockchain and Etheruem (ETH) on the Ethereum blockchain). It allows the blockchain to store ownership information securely, transparent and ensures that any state changes adhere to its ruleset. This layer can be seen as the base for trustless execution and serves as a settlement and dispute resolution layer.
Asset Layer
This layer consists of all assets that are issued on top of the settlement layer. This includes the native protocol asset as well as any additional assets that are issued on this blockchain (usually referred to as tokens). For example stablecoins such as USDT and USDC, are USD-backed stablecoin and are available as ERC-20 tokens on the Ethereum blockchain.Another distinct category are so-called non-fungible tokens (NFTs). NFTs are tokens that represent unique assets, that is, collectibles. They can either be the digital representation of a physical object such as a piece of art or land or propety, making them subject to the usual counterparty risk, or a digitally native unit of value with unique characteristics. In any case, the token’s non-fungibility attributes ensure that the ownership of each asset can be individually tracked and the asset precisely identified. NFTs usually are built on the ERC-721 token standard.
Protocol Layer
This layer provides standards for specific use cases such as decentralized exchanges, debt markets, derivatives, and on-chain asset management. These standards are usually implemented as a set of smart contracts and can be accessed by any user (or DeFi application). As such, these protocols are highly interoperable.
Application Layer
As the name suggest, the application layer is the front end UI applications that connect to individual protocols also known as Digital Applications (DApps). This is normally a web browser or mobile apps that makes the smart contract interactions easier to use. Most common applications in the cryptocurrency ecosystem, such as decentralised exchanges (DEXs) and lending services, reside on this layer.