How Does DeFi Work?
Decentralized Finance (DeFi) refers to the financial services built on blockchain technology, predominantly Ethereum. It operates without intermediaries, thereby promoting open access, transparency, and greater financial inclusion.
Core Components of DeFi
- Smart Contracts: Self-executing contracts with the terms of the agreement directly written into code, enabling trustless transactions.
- Liquidity Pools: Aggregated funds provided by users that allow others to borrow or trade assets while wholesalers can earn fees.
- Decentralized Exchanges (DEXs): Platforms that facilitate peer-to-peer trading of cryptocurrencies without a central authority.
- Stablecoins: Cryptocurrencies pegged to stable assets, providing a volatile-free medium for transactions.
How DeFi Functions
Users interact with DeFi applications by connecting their crypto wallets. Through smart contracts, users can lend, borrow, or trade assets in a decentralized manner. For example, if a user wants to lend their cryptocurrency, they deposit into a liquidity pool. In return, they earn interest paid by those who borrow from the same pool.
Benefits of DeFi
DeFi democratizes finance by enabling anyone with an internet connection to access financial services, eliminating barriers and reducing costs traditionally associated with financial intermediaries.