What is DeFi and Why is Everyone Talking About Smart Contracts and DApps?

DeFi blockchain

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DeFi is a hot topic in the world of cryptocurrency right now.

DeFi is short for decentralised finance. Not long ago it was called open finance, but this term seems to have gone out of fashion.

The term DeFi describes decentralised financial products and services which exist on the blockchain outside traditional banks or monetary institutions.

The explosion in DeFi is revolutionising the way people access financial products and services.

Now, everything from loans and investments to crowdfunding and interest-bearing savings accounts are available without having to go through a centralised middleman.

Popular DeFi applications include:

  • Lending and savings platforms (BlockFi and Nexo are two examples of this).
  • Cryptocurrency exchanges, often referred to as decentralised exchanges (DEXs)
  • More complex crypto earning strategies such as yield farming a liquidity mining

Unlike high-street banks, you can often access DeFi without needing to prove your identity or gives any personal information.

Instead, they’re facilitated through a global peer-to-peer network utilising blockchain technology.

As such, DeFi is liberating people from the constraints of the traditional system and given them greater control over their financial situation.

Most DeFi applications run on the Ethereum (ETH) network – a popular cryptocurrency which is second only to Bitcoin in terms of its market capitalisation (market cap).

They utilise what are know as smart contracts to replication the products and services offered by traditional providers.

Top DeFi tokens

At the time of writing, some of the top DeFi tokens by market cap are:

  • Uniswap (UNI)
  • Chainlink (LINK)
  • Wrapped Bitcoin (WBTC)
  • Dai (DAI)
  • Aave (AAVE)
  • Maker (MKE)
  • PancakeSwap (CAKE)
  • Yearn.finance (YFI)
  • SushiSwap (SUSHI)
  • Compound

What are smart contracts?

A smart contract is a contract coded onto the blockchain which completes when the terms agreed by the parties involved, such as a buyer and seller, are met.

The rules of the contract are written in the code which enforces the terms while ensuring the deal transacts only when all the conditions are met.

Anyone can write and deploy a smart contact if they’re familiar with the developer languages used, such as Solidity and Vyper.

You also need to own ETH to pay the ‘gas’ fee to execute the contract and pay for the ‘mining’ involved.

The contract rules can be arbitrary as well. For example, you could stipulate that certain weather conditions must be met in order for the contract to execute and this would then form part of the agreement.

Smart contracts also enable transactions to be carried out anonymously. However, the blockchain makes the transaction itself traceable, unmodifiable and irreversible.

This is because the record of the contract and the code its constantly monitored to ensure it has complied with its original terms.

How do smart contracts differ from traditional automated contracts?

The main difference is that the contract is decentralised – there are no third parties involved to interfere with the terms or funds involved.

An added layer of trust is written into smart contracts because of the constant monitoring and checking by the vast network of blockchain participants.

What are the downsides of DeFi and smart contracts?

We’ve covered some of the benefits of DeFi and smart contracts, such as new financial freedoms and the trust blockchain technology brings, but there are a few disadvantages as well.

These include:

  • There is no scope for any deliberate ambiguity in the contract because the terms of smart contracts are written in code. At the moment, there’s no way of coding this ambiguity.
  • The nature of smart contracts mean they cannot be adjusted once deployed on the blockchain.
  • The unregulated nature of the cryptosphere and the lack of legal protection for participants.
  • The potential – however unlikely – for weakness in the code to be discovered and exploited, exposing people to financial loss.

What are DApps?

DApps (decentralised applications) are software applications built on a decentralised network that run on top of the blockchain and communicate with smart contracts.

DApps cover a wide range of industries, including decentralised financial exchanges (DEXs), cryptocurrency token exchanges (such as Uniswap), online casinos and games.

In the ‘real world’ more and more companies are starting to engage with DApps and blockchain technology.

Use cases include order tracking, and removing banks and other institutions from global financial transactions.

Another example is Brave a DApp-based web browser and advertising platform where users earn Basic Attention Tokens (BAT) based on their activity.

They can also ‘tip’ content creators with the BAT cryptocurrency as a reward for their efforts directly through the browser.

Related post: The top 5 crypto savings and investment accounts 2021

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Disclaimer: This article is for informational purposes only and does not constitute financial or investment advice.

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