Decentralized finance

Decentralized finance (often stylized as DeFi) provides financial instruments and services through smart contracts on a programmable, permissionless blockchain.

[1] DeFi platforms enable users to lend or borrow funds, speculate on asset price movements using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts.

Through a set of smart contracts that govern the loan, repayment, and liquidation processes, MakerDAO aimed to maintain the stable value of DAI in a decentralized and autonomous manner.

[9][10][needs update] In June 2020, Compound Finance, a decentralized finance protocol enabling users to lend or borrow cryptocurrency assets and which provides typical interest payments to lenders, started rewarding lenders and borrowers with a cryptocurrency called Comp.

[15] DeFi revolves around decentralized applications, also known as DApps, that perform financial functions on distributed ledgers called blockchains, a technology that was made popular by Bitcoin and has since been adapted more broadly.

[4] These smart contracts, or DeFi protocols, typically run using open-source software that is built and maintained by a community of developers.

[25] Another DeFi protocol is Uniswap, which is a decentralized exchange (DEX) set up to trade tokens issued on Ethereum.

[citation needed] In transactions made through decentralized exchanges, the typical third party entities which would normally oversee the security and transfer of assets (e.g. banks, stockbrokers, online payment gateways, government institutions, etc.)

Some common methods of operation include the use of smart contracts or order book relaying – although many other variations are possible, with differing degrees of decentralization.

[33] Due to a lack of KYC processes, and no way to revert a transaction, users are at a loss if they are ever hacked for their passwords or private keys.

[34] Additionally, liquidity providers staking in DeFi protocols can suffer what is called an impermanent loss if, when withdrawn, the token pairs they have invested in have altered in value ratio significantly.

To provide some protection against front running attacks, many DeFi exchanges offer a slippage tolerance option for end-users.

The governance of a DeFi platform, typically as part of a Decentralized Autonomous Organization, is done through tokens that grant voting rights and are distributed amongst participants.

[40] In a Tweet, Charlie Lee, the creator of Litecoin spoke out and claimed an exchange cannot be decentralized if it can lose or freeze customer funds.

Inexperienced investors are at particular risk of losing money because of the sophistication required to interact with DeFi platforms and the lack of any intermediary with customer support.

[47] In October 2021, the FATF included DeFi in the guidance for crypto service providers, making the authority's aim to regulate this type of asset.They are expecting each individual country to determine if individuals involved in DeFi can be considered a virtual asset provider and be subjected to the FATF's guidelines.