How Does Decentralized Finance Work?

How Does Decentralized Finance Work?

Decentralized finance is a sub-industry in the world of cryptocurrency and something that has been slowly getting more and more popular over the years. But what is it, how does it work, and why do people use it?

What is DeFi?

Decentralized Finance (DeFi) is the idea of any money-based activity that is backed by multiple servers or platforms at once. In theory, the idea means that there is not a central server or group that can be used to modify the contents of a transaction – it has to go through all of them.

This is a great idea for dealing with corruption or malicious tweaks to existing systems, like people who have tried to hack banks to add non-existent money into their accounts. Most finance systems are centralized, but a few decentralized systems already exist and are being used.

In general, these systems are best used for any transaction that needs to be kept secure and private. Hacks can’t be spread throughout the network, a single server breaking will not ruin the system, and they can be built for almost any specific use.

What can DeFi be used for?

DeFi is ideal for creating any kind of financial system that should be accessible to anybody. This includes things like insurance, lending, and borrowing money, or transferring funds to another person. With no centralization, these basic functions can’t easily be manipulated.

It can also be used for stablecoins, as part of crypto exchanges, for margin trading, or for a whole host of other uses. Since they are not centralized, they can only change when all servers agree that a change needs to be made, massively reducing the number of errors in the system.

This becomes even more powerful when combined with a proper blockchain system. Since a blockchain can log every single transaction in the ledger forever, it is almost impossible to hack into the system and simply change a value because every other server will contain the original details.

Thanks to this, somebody who does hack into a decentralized finance system will not only have their work undone, but it will be much more obvious. This allows backdoors and vulnerabilities to be discovered without any threat to the people using the system.

How are decentralized finance systems made?

DeFi systems are difficult to create without a good blockchain, so most of them are built on a blockchain framework, such as the Ethereum DIY platform. From there, programmers can create the code and smart contracts needed to make a full financial system from scratch.

These smart contacts are basically programmed instructions that explain how the system works, acting as the master of the servers. Not only does this govern the entire setup, but it can also help point out changes that were not supposed to happen or attempts to alter the system somehow.

Each system is different, and each one will contain particular quirks or extra functions that others do not have, meaning that there is not a standard design for any of them. Even when based on an existing blockchain (usually Ethereum), they can be wildly different systems.

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