How does DeFi work?
Decentralized Finance (DeFi) refers to a blockchain-based financial system that operates without central authorities or intermediaries. It utilizes smart contracts on platforms like Ethereum to facilitate peer-to-peer transactions, lending, and trading of assets.
Key Components of DeFi
- Smart Contracts: Self-executing contracts with the terms of the agreement directly written into code, enabling automation and trustless transactions.
- Decentralized Applications (dApps): Applications built on blockchain networks that facilitate financial services, such as lending platforms and decentralized exchanges (DEX).
- Liquidity Pools: Pools of assets locked in smart contracts, allowing users to trade and earn interest without relying on traditional market makers.
How Users Interact with DeFi
Users interact with DeFi platforms by connecting their crypto wallets. They can lend, borrow, or trade assets directly from their wallets, enabling greater financial autonomy. The use of decentralized tokens, often representing a stake in a protocol, allows users to earn yields and participate in governance.
Benefits and Risks
While DeFi offers benefits like lower fees and accessibility, it also poses risks such as smart contract vulnerabilities and regulatory uncertainty. Users should conduct thorough research and exercise caution when investing in DeFi projects.