DeFi (Decentralized Finance)

DeFi, short for decentralized finance, refers to a broad category of financial services built on blockchain technology, primarily Ethereum. It aims to create an open, permissionless, and transparent peer-to-peer financial ecosystem without traditional intermediaries like banks.

Powered by decentralized protocols and smart contracts, DeFi applications include decentralized versions of traditional financial products and services, such as DEXs (decentralized exchanges), lending and borrowing platforms, insurance, and synthetic assets. They also encompass new concepts like bridges, stablecoins, yield farming, and decentralized autonomous organizations (DAOs).

DeFi offers several significant advantages over traditional financial systems, including:

• Accessibility and Inclusivity: Built on decentralized blockchain infrastructure, DeFi applications do not require the KYC process. This allows anyone with an internet connection and a digital wallet to participate in DeFi activities, regardless of their identity.
• Transparency: All transactions are recorded on the blockchain, ensuring a high level of accountability and reducing the risk of fraud.
• Sovereignty: DeFi is peer-to-peer and eliminates third-party intermediaries, meaning the ownership of funds never leaves users’ hands. This enables users to retain control over their assets and personal data.
• Fast Innovation: The open-source nature of the DeFi sector accelerates development, allowing for rapid iteration and improvement of DeFi protocols and applications.

However, DeFi also comes with notable risks and challenges, such as:

• Code Vulnerabilities: Bugs and vulnerabilities in smart contracts can lead to substantial financial losses.
• Regulatory Uncertainty: The evolving regulatory landscape could impact the growth and adoption of DeFi.
• Technical Complexity: The high entry barrier due to the technical complexity of using DeFi platforms can limit broader adoption.

The rapid growth of DeFi highlighted scalability issues on the Ethereum network, such as high gas fees and slow transaction speeds due to increased transaction volume and network congestion. This underscored the urgent need for scalable solutions, leading to the development of Layer 2 and rollup technologies aimed at increasing transaction throughput and reducing costs by handling transactions off Layer 1.