What is DeFi?
Over the course of the last year, a new use case for blockchain technology has emerged called DeFi, which is short for ‘decentralized finance. The current wave of DeFi started in the summer of 2020, where these strange financial services started springing up in droves on the Ethereum blockchain. But what is it exactly? In one sentence, DeFi creates an ecosystem
where people may use permissionless financial applications without a central authority. If this doesn’t make much sense to you right now, don’t worry, it will be more clear by the end of the article.

The Ethereum Blockchain
DeFi started, and is still most prominent, on a blockchain called ‘Ethereum.’ Ethereum allows its users to create programs on top of it called ‘smart contracts’ that run without a central authority, and can transfer value that is built on top of the network. Since these programs operate in this decentralized, used facing fashion, the effect is to create an alternative financial system that is permission-less, and based mostly on code. To be more clear, we’ll briefly discuss some use cases, and some of the different ‘dApps’, or decentralized applications that are built on top of Ethereum.

Major Usecases and dApps

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The major dApps in DeFi allow use cases such as lending, borrowing, buying options, and investing in synthetic assets. It’s a quickly evolving industry, so the possibilities are constantly expanding as more and more creative use cases are figured out. The most basic use cases are lending and borrowing, and these were some of the first to be created on DeFi. Today there are a few major dApps offering lending markets, among them are AAVE and Compound. Both of these work very similarly, users may deposit assets and either lend them out for yields or borrow against them at a market set rate. It is a truly free
market where the more people there are buying the higher the borrowing rates are, and vice versa.
The major drawback of most decentralized lending platforms is that any loan taken out must be collateralized by other crypto assets, often by as much as two times the value of the loan. This is necessary to run them in a decentralized way right now, but can make them inconvenient for those who don’t own crypto, or who couldn’t lock their coins up for one reason
or another. On the other hand, for those who have an asset that they know they are going to hold for a long time the lockup can be a non problem, and these platforms can become incredibly useful.
Another interesting use case is in the markets for synthetic assets based on stocks, commodities, or national currencies. Many different dApps, and in some cases centralized crypto exchanges, have been experimenting in bringing assets that track real-world assets to defi. This is especially useful because it allows those who want to invest in these real assets to use their investments in the deFi ecosystem. The biggest and most important innovation here is the national currency derivatives called stablecoins, which play a key role in a world of volatile cryptocurrencies. Through stablecoins, users can easily swap into exposure to the United States Dollar or other currencies without taking their money out of defi, and are able to use the
stablecoin to do things like interacting with decentralized lending platforms.

Different Chains
Though DeFi has primarily lived on Ethereum to this point, there are other similar blockchains offering the same services. People might choose to use other chains due to the drawbacks of Ethereum, the biggest of which is an inconsistent and often pricy transaction expense. These other chains can either be ‘layer 2’ chains that are somewhat networked with Ethereum, or entirely separate blockchains. Some of the most popular layer 2 chains are Polygon and the xDai Chain. For separate blockchains: Binance, Avalanche, Solana, and Fantom are some of the commonly used. All of these chains carry their own separate advantages and disadvantages, but most have been built
with a goal of making transactions extremely cheap.

Is using DeFi safe?
The short answer to this question is no. Defi is extremely risky and experimental, and though it has some great promises to offer, anyone investing or using it right now should be aware of the potential to lose all of their money. As the systems are proven more, this will slowly shift, but there are a couple major problems in the ecosystem right now.
For one there is an epidemic of hacks and exploits in decentralized protocols. This is the main drawback of trying to build code based finance; code has flaws and there are often massive incentives to find them. There have been many cases of hacks where value in the tens of millions of dollars was stolen. The good news is that as security procedures improve, and protocols figure out what the most common exploit routes are, hacks on major protocols are
decreasing in frequency.
The risk of hacking isn’t just on the protocol side though, individual users should also be aware. Hackers and scammers are always looking for opportunities to exploit people through routes like phishing attacks, sim swaps, fraudulent dApps, and other paths. Anyone who has gotten into DeFi should always be using the best possible security practices, such as using two
factor authentication on all of their personal accounts and using a hardware wallet for their crypto funds.

Future of DeFi
Decentralized finance has many problems, but also a huge use case in its quest to offer easily accessible, cheap, and fair financial solutions. As the kinks are ironed out, it seems inevitable that it will find more and more adoption. Once security becomes less of an issue, it will do this likely by simply offering a better product than legacy financial systems are able to, due to low operational costs and the ability to go direct to users rather than through middle men.

Whatever this ends up looking like in practice, it will be interesting to watch.