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What Is Decentralized Finance (DeFi) and How Does It Work?

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What Is Decentralized Finance (DeFi) and How Does It Work?

What Is Decentralized Finance (DeFi)?

Decentralized finance (DeFi) is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies.

In the U.S., the Federal Reserve and Securities and Exchange Commission (SEC) define the rules for centralized financial institutions like banks and brokerages, which consumers rely on to access capital and financial services directly. DeFi challenges this centralized financial system by empowering individuals with peer-to-peer transactions.

Key Takeaways

  • Decentralized finance, or DeFi, uses emerging technology to remove third parties and centralized institutions from financial transactions.
  • The components of DeFi are cryptocurrencies, blockchain technology, and software that allow people to transact financially with each other.
  • DeFi is still in its infancy and subject to hacks and thefts because of sloppy programming and a lack of security testing before applications are launched.

Investopedia / Joules Garcia

How Decentralized Finance (DeFi) Works

Through peer-to-peer financial networks, DeFi uses security protocols, connectivity, software, and hardware advancements. This system eliminates intermediaries like banks and other financial service companies. These companies charge businesses and customers for using their services, which are necessary in the current system because it’s the only way to make it work. DeFi uses blockchain technology to reduce the need for these intermediaries.

Blockchain

A blockchain is a distributed and secured database or ledger. In the blockchain, transactions are recorded in blocks and verified through automated processes. If a transaction is verified, the block is closed and encrypted; another block is created with information about the previous block, along with information about newer transactions.

The blocks are “chained” together through the information in each proceeding block, giving it the name blockchain. Information in previous blocks cannot be changed without affecting the following blocks, so there is no way to alter a blockchain. This concept, along with other security protocols, provides the secure nature of a blockchain.

Using applications called wallets that can send information to a blockchain, individuals hold private keys to tokens or cryptocurrencies that act like passwords. These keys give them access to virtual tokens that represent value. Ownership of the tokens is transferred by ‘sending’ an amount to another entity via a wallet, whose wallet, in turn, generates a different private key for them. This secures their ownership of the token, and the blockchain design prevents the transfer from being reversed.

Applications

DeFi applications are designed to communicate with a blockchain, allowing people to use their money for purchases, loans, gifts, trading, or any other way they want without a third party. These applications are programs installed on a device like a personal computer, tablet, or smartphone that make it easier to use. Without the applications, DeFi would still exist, but users would need to be comfortable and familiar with using the command line or terminal in the operating system that runs their device.

DeFi applications provide an interface that automates transactions between users by giving them financial options to choose from. For example, if you want to make a loan to someone and charge them interest, you can select the option on the interface and enter terms like interest or collateral. If you need a loan, you can search for providers, which could range from a bank to an individual who could lend you some cryptocurrency after you agree on terms.

Some applications let you enter parameters for the services you’re looking for and match you with another user. Because the blockchain is a global network, you could give or receive financial services to or from anywhere in the world.

Decentralized finance does not provide full anonymity. Transactions do not include an individual’s name but are traceable by anyone with the knowledge to do so. This includes governments and law enforcement, which, at times, are necessary for protecting an individual’s financial interests.

Goals of Decentralized Finance

Peer-to-peer (P2P) financial transactions are one of the core premises behind DeFi, where two parties agree to exchange cryptocurrency for goods or services without a third party involved.

Using DeFi allows for:

  • Accessibility: Anyone with an internet connection can access a DeFi platform, and transactions occur without geographic restrictions.
  • Low fees and high interest rates: DeFi enables any two parties to negotiate interest rates directly and lend cryptocurrency or money via DeFi networks.
  • Security and Transparency: Smart contracts published on a blockchain and records of completed transactions are available for anyone to review but do not reveal your identity. Blockchains are immutable, meaning they cannot be changed.
  • Autonomy: DeFi platforms don’t rely on centralized financial institutions. The decentralized nature of DeFi protocols mitigates the need for and costs of administering financial services.

Peer-to-peer lending under DeFi doesn’t mean there won’t be any interest and fees. However, it does mean that you’ll have many more options since the lender can be anywhere in the world.

What Is an Example of DeFi?

DeFi is an all-inclusive term for any application that uses blockchain and cryptocurrency techniques or technology to offer financial services. Some of these applications can provide anything from basic services like savings accounts to more advances services like providing liquidity to businesses or investors. One of the more notable DeFi service providers is Aave, which is a “decentralized non-custodial liquidity market protocol” that allows anyone to participate as a liquidity supplier or borrower.

Aave lets you stake any of your crypto-assets to earn interest income from users who might borrow your assets.

Decentralized Finance Uses

Decentralized finance, originally conceived of as a way to bring financial services like loans and banking to those who don’t have access to them, has morphed into an industry where you can take part in many different sectors or endeavors. Here are a few of the most popular:

  • Decentralized exchanges: The top preference for defi app users is accessing decentralized exchanges. Exchanges like Uniswap and PancakeSwap have apps that let you interact with other cryptocurrency users.
  • Liquidity providers: Liquidity is the ability to sell assets quickly, a problem many cryptocurrency users have encountered. Liquidity providers are generally pools where users place funds so exchanges can provide selling opportunities for their users.
  • Lending/Yield Farming: There are hundreds of defi apps available that provide lending. Generally, they operate the same way as a liquidity pool, where users lock their funds in a pool and let others borrow them, receiving interest on their loans—called yield farming. Many provide flash loans, where no collateral is required from the borrower.
  • Gambling/Prediction Markets: Millions of dollars in cryptocurrency are used everyday gambling using defi apps like ZKasino, Horse Racing Slot Keno Roulett, Azuro, and UpvsDown. Prediction markets are platforms that let you place bets on the outcome of nearly any event.
  • NFTs: The market for non-fungible tokens has cooled somewhat, but they are still popular with niche investors and collectors.

How to Get Involved in DeFi

Becoming involved in decentralized finance might seem intimidating at first, but there are many ways to do so. The first thing you should do if you want to get into DeFi is to research the activities that interest you the most. You’ll need a wallet, but because there are so many to choose from, you’ll need to learn more about them and find the one that appeals to you.

Once you identify your wallet and activity, you can find a reputable exchange that provides the activity you want to get involved in or use, buy some cryptocurrency, and get started.

Concerns About DeFi

Decentralized finance is constantly evolving. It is unregulated, and its ecosystem is vulnerable to faulty programming, hacks, and scams. For example, one of the main ways hackers and thieves steal cryptocurrency is through weaknesses in DeFi applications.

Laws have not yet caught up with advances in technology. Most current laws were crafted based on the idea of separate financial jurisdictions, each with its own set of laws and rules. DeFi’s borderless transaction ability presents essential questions for this type of regulation. For example:

  • Who is responsible for investigating a financial crime that occurs across borders, protocols, and DeFi apps?
  • Who would enforce the regulations?
  • How would they enforce them?

DeFi Hype

Just like other blockchain- and cryptocurrency-related projects, businesses, and activities, decentralized finance is subject to considerable hype and misinformation, hoping to attract users and their money. Cryptocurrency, blockchain, and all technologies associated with them are also subject to extreme price volatility.

Lots of Money in Crypto, But Not as Much as You’d Think

There is a considerable amount of money flowing through cryptocurrency exchanges, but it isn’t nearly as much as you might be led to believe. Most people still use the traditional financial systems we are all used to. For example, only 0.56% of all money is tied up in cryptocurrency and decentralized finance—a very small figure that should encourage you to do your research to learn if using or investing in DeFi apps, platforms, and cryptocurrency is worth it.

Crypto Winters

A crypto-winter is a period where crypto prices continuously move down and then stay down—sometimes tens of thousands of dollars. The last one occurred between 2022 and 2023. Prices had been rising significantly before 2022 as investors turned to anything they could find following the initial outbreak of COVID-19 and the ensuing pandemic. During that time, they discovered Bitcoin was not only holding value; it was increasing as well—but this was most likely due to their own self-fulfilling prophecies and hype as they drove the price increases themselves.

But toward the end of 2022, prices began declining and stayed there. Billions of dollars were lost during this time. During this period, there were no rumors of substance or any regulatory developments (in the U.S.) beyond a perceived campaign of persecution orchestrated by the Securities and Exchange Commission. However, when rumors began circulating about a Spot Bitcoin ETF approval in October 2023, the hyping began again, and prices rose. When the approval of 11 Bitcoin Spot ETFs was announced in January 2024, prices climbed steadily for a few months (supposedly ending the winter) until a sideways market emerged yet again in March 2024.

Is It Worth It?

DeFi might be just what you’re looking for regarding your finances. However, it might not—the decentralized finance industry is still in its infancy and evolving, making it somewhat of a gamble for most people.

The low amount of actual money invested in cryptocurrency and the effects that hype has on prices should make you consider whether investing in decentralized finance is worth it. If you have money you can afford to lose, the space can be very profitable—but the amount of losses can be just as significant.

If you don’t have money to lose and are looking for ways to fund your retirement or grow your portfolio or net worth over time, defi and cryptocurrency should be the last investment you should consider. They are still too new and volatile to risk your future on.

What Does Decentralized Finance Do?

The goal of DeFi is to challenge the use of centralized financial institutions and third parties involved in all financial transactions.

Is Bitcoin Part of Decentralized Finance?

Bitcoin is a cryptocurrency. DeFi is designed to use cryptocurrency in its ecosystem, so Bitcoin isn’t DeFi as much as it is a part of it.

What Is Total Value Locked in DeFi?

Total value locked (TVL) is the sum of all cryptocurrencies staked, loaned, deposited in a pool, or used for other financial actions across all of DeFi. It can also represent the sum of specific cryptocurrencies used for financial activities, such as ether or bitcoin.

Is DeFi a Good Investment?

Investing in DeFi involves purchasing a cryptocurrency that is used in DeFi and is susceptible to hacks. DeFi hacking has been an issue for several years, but according to the blockchain analysts at Chainalysis, the trend dropped significantly in 2023. However, this doesn’t mean it won’t pick back up again. Like all cryptocurrency and blockchain investments, there are significant risks involved.

The Bottom Line

Decentralized finance (DeFi) is an emerging financial technology that challenges the current centralized banking system. DeFi attempts to eliminate the fees banks and other financial service companies charge while promoting peer-to-peer transactions.

DeFi, like the blockchains and cryptocurrencies it supports, is still in its infancy. Significant hurdles must be overcome before it can replace the existing financial system, which has its own issues that are difficult to resolve. Lastly, financial service companies and banks are not going to be replaced without a fight—if there is a way for them to profit from the transition to a blockchain-based financial system, they will find it and make sure they are part of it.

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Blockchain Technology Will Transform Water Access and Management Globally

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Blockchain Technology Will Transform Water Access and Management Globally

Disclosure: The views and opinions expressed here are solely those of the author and do not represent the views and opinions of the crypto.news editorial team.

Access to clean water is a basic human need, yet billions of people around the world still struggle to get it. According to the World Health Organization, over 2 billion people live in countries suffering from severe water stress, and this number is expected to continue to grow due to climate change and population growth.

Traditional water management systems have struggled to address these challenges, often hampered by inefficiencies, lack of transparency, and misallocation of resources. Blockchain technology offers a promising solution to these challenges, providing equitable access and sustainable use of this crucial resource.

The current state of water management

Water management today faces several pressing issues. Inefficiencies in water supply, distribution, and use, coupled with a lack of real-time monitoring, often result in resource waste and misallocation. Many water sources fail to realize their full potential due to infrastructure and financing shortfalls. For example, the Environmental Protection Agency (EPA) report indicated that the United States would need to invest $625 billion over the next 20 years to repair, maintain and improve the country’s drinking water infrastructure due to aging pipes and other infrastructure problems. Additionally, in the United States alone, household leaks can to waste nearly 900 billion gallons of water per year nationwide. This is equivalent to the annual domestic water consumption of nearly 11 million homes.

Furthermore, corruption and mismanagement of water resources can cause unequal distribution, with disadvantaged communities often bearing the brunt of water scarcity. For example, South Africa is struggling with myriad challenges to its water security: drought, inadequate water conservation measures, outdated infrastructure, and unequal access to water resources. The country faces significant water scarcity, with demand expected to outstrip supply by 2030, creating a projected gap of 17%.

Furthermore, the global water industry is highly monopolized, with a few key players controlling a significant share of the market. These companies exert substantial influence over the water supply chain, often prioritizing profit over equitable distribution and environmental responsibility. This concentration of power can lead to inflated prices and limited access for vulnerable populations. The global bottled water market alone is projected to reach $509.18 billion by 2030, with these large companies capturing a significant share of revenue. This monopolization exacerbates existing inequalities in water access and highlights the need for more decentralized and community-driven water management solutions.

Source: Grand View Search

The potential of blockchain in water management

Blockchain technology can address these issues by providing a transparent, secure, and decentralized platform for water resource management. This approach offers several advantages:

  • Transparency and accountability. Blockchain’s immutable ledger ensures that all transactions and data entries are transparent and cannot be changed once recorded. This transparency can reduce corruption and ensure that water resources are allocated fairly and efficiently. For example, blockchain can be used to track water usage from source to end user, providing a clear record of how water is distributed and used. This level of transparency can help hold authorities accountable and manage water resources sustainably.
  • Efficient resource management. Blockchain can facilitate the creation of smart contracts, which are self-executing contracts with the terms of the agreement written directly into the code. These contracts can automate water distribution based on real-time data, directing water to where it is needed most. For example, smart contracts could be used to manage urban water supply systems, automatically adjusting water distribution based on real-time consumption patterns and demand. This can help optimize water use, reduce waste, and ensure that households and businesses receive the right amount of water at the right time.

In Dubai, the Dubai Electricity and Water Authority (DEWA) has implemented a blockchain-based smart water network initiative as part of its broader smart city strategy. This project integrates blockchain technology with IoT sensors to monitor water usage in real time, manage distribution, and detect leaks. The decentralized ledger ensures data integrity and transparency, enabling more efficient water management and reduced waste. DEWA’s initiative aims to improve sustainability and resource management in the rapidly growing city, highlighting the potential of blockchain to support urban water management and conservation efforts.

Community participation and ownership

Through blockchain, individuals can directly control and monetize their access to water resources, eliminating the need for third-party intermediaries. This direct control model allows local communities to make collective and transparent decisions about their water use. By managing their water directly from the source, communities can tailor water management practices to their specific needs, promoting equitable distribution and encouraging a sense of accountability and stewardship.

Additionally, future models could allow people to monetize their access to water through web3 technologies. For example, a community-to-business (C2B) model could allow people to sell water directly to companies. In this model, people do not have to own the water directly, but can profit by staking their tokens during event sales pools. This approach not only supports sustainable water management, but also creates economic opportunities for community members. Additionally, a “Burn to Secure” protocol can be used to provide water allocation rights. This protocol provides a true sense of water security and financial opportunity by allowing people to redeem their rights. This system not only secures future water allocations, but also increases token scarcity and value.

Additionally, a pure sense of investment is achieved through investments in water sources. This leads to potential financial returns and dividends by addressing the inefficiencies in water supply mentioned above. By investing to finance infrastructure projects, such as building factories and improving distribution systems, more water can be brought to communities, creating additional economic opportunities.

Monetizing water access through the C2B model, the “Burn to Secure” protocol, and investments in water sources all generate economic benefits for the community, promoting a more equitable and efficient water management system.

Overcoming challenges

While blockchain technology has the potential to improve water management, there are challenges to its adoption. The complexity of blockchain systems and the need for technological infrastructure can be barriers, especially in developing regions. Additionally, there are concerns about the significant energy consumption of blockchain networks. However, technological advances and the development of more energy-efficient blockchain solutions are helping to alleviate these concerns. Additionally, education and capacity building are key to ensuring stakeholders understand how to effectively use blockchain technology. Governments, NGOs, and private sector partners need to work together to provide training and support to communities and water management authorities.

Blockchain technology offers a practical and effective means to improve water management. In addition to addressing inefficiencies, blockchain empowers communities, promotes sustainable practices, and opens up new economic opportunities through models like community-to-business (C2B). As we face the growing challenges of climate change and population growth, blockchain is not only an innovative solution, but represents a fundamental shift in the way we manage and value water resources. Adopting blockchain in water management is essential to creating a sustainable and equitable future by changing the way we interact with and protect our most vital resource.

Jean-Hugues Gavarini

Jean-Hugues Gavarini

Jean-Hugues Gavarini is the CEO and co-founder of LAKE (LAK3), a real-world asset company leveraging blockchain technology to decentralize access to the global water economy. LAKE aims to ensure access to clean water for all, protect water resources, and deliver water to those in need through innovative technologies. Jean-Hugues has a diverse career spanning the luxury, fashion, and footwear industries. His career path includes notable successes at Mellow Yellow, Cremieux, and Tod’s. Raised between Silicon Valley and the French Alps, Jean-Hugues has always been immersed in technology and freshwater resources. In 2018, Jean became the CEO of Lanikea Waters, a water solutions entity based in the French Alps. In 2019, the concept of LAKE was born, embodying his commitment to innovation and sustainability.

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Blockchain and AI Expo 2024

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Blockchain and AI Expo 2024

With rapid advances in the world of AI and blockchain, there are opportunities to leverage the security and transparency features of blockchain to improve the reliability and trust of AI systems and data transactions.

Explore the synergy of these advanced technologies in virtual mode Blockchain and AI Expowhich takes place on October 31, 2024 TO 10:00 GMT.

The event features cutting-edge presentations led by leading experts in evolving fields. Presentations are set to explore opportunities and challenges in the fusion of blockchain and AI, real-world applications, ethics, innovations in environmental sustainability, and more!

Gain a comprehensive understanding of how these technologies can synergistically drive innovation, optimize operations, and promote strategic growth opportunities. Develop your knowledge to facilitate informed decision making and give your company a competitive edge in the growing technology landscape.

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Nigeria Eyes National Blockchain Nigerium for Data Sovereignty

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Nigeria round sign Futuristic satellite view of the world

Nigeria is keeping an eye on a new native blockchain network to protect the country’s data sovereignty.

According to local media, a team from the University of Hertfordshire has proposed the new blockchain, Nigeriato the National Information Technology Development Agency (NITDA).

Chanu Kuppuswamy, who leads the team, argued that relying on blockchain networks whose developers are located in other regions poses national security risks to the Nigerian government. He further said that Nigerium would allow the West African nation to customize the network to meet specific needs, while also promoting data sovereignty.

In his presentation, Chanu cited the recent migration of Ethereum to test of participation (PoS) consensus as an instance in which no Nigerians were involved but whose impact is far-reaching.

“Developing an indigenous blockchain like Nigerium is a significant step towards achieving data sovereignty and promoting trust in digital transactions in Nigeria,” he said.

While receiving the proposals in Abuja, NITDA’s Kashifu Abdullahi acknowledged the benefits a local blockchain would bring to Nigeria, including increased security of citizens’ data.

However, a NITDA spokesperson later clarified that Nigerium is still at the proposal stage and that the government has not yet decided whether to proceed or not.

“The committee is still discussing the possibility with stakeholders. Even if a decision is finally made, there is no guarantee that the name will be Nigerium,” the spokesperson told the media.

Nigerium’s reception in the country has been mixed. Some, like financial analyst Olumide Adesina, To say the network is “dead on arrival”. He believes the Nigerian government’s poor record in following through on its big technology plans will claim another victim. He pointed to the eNaira as a missed opportunity whose chances of success were much higher than those of Nigerium.

Others welcomed the proposal. Chimezie Chuta, who chairs the renewed The Nigerian Blockchain Policy Committee is “extremely optimistic“that Nigerium will be more successful than eNaira.

Speaking to a local news agency, Chuta stressed that eNaira failed because the central bank initiated the project on its own, without involving any stakeholders.

“They just cooked it and expected everyone to like it. [With Nigerium]there will be a lot of collaboration,” he said.

Registration of property title, digital identity and Certificate Verification are among the use cases that Nigerium is expected to initially target. However, Nigeria has already made progress in some of these fields through public blockchains.

SPPG, a leading school in governance and politics, announced in May the country’s first blockchain certificate verification system. Built on the The BSV BlockchainIt was developed in collaboration with the blockchain data recording company VX Technologies and local lender Sterling Bank.

Watch: The Future Has Already Arrived in Nigeria

Youtube VideoItalian: https://www.youtube.com/watch?v=M40GXUUauLU width=”560″ height=”315″ frameborder=”0″ allowfullscreen=”allowfullscreen”>

New to blockchain? Check out CoinGeek Blockchain for Beginners section, the definitive guide to learn more about blockchain technology.



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Cambodian CBDC Developer to Build Palau Bond Market on Blockchain: Report

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Cambodia’s CBDC developer to construct bond market for Palau on blockchain: report

A Japanese fintech developer will build a blockchain-based bond market gateway for Palau, aiming to launch a trial in 2024 and a full launch the following year.

Japanese fintech developer Suramitsubest known for developing a central bank digital currency (CBDC) for Cambodia, is intended to build a Blockchain-gateway to the bond market based on the Pacific island nation of Palau, Nikkei He learned.

Soramitsu won the contract and plans to introduce the market on a trial basis in fiscal 2024, with a full launch scheduled for the following year, allowing the Palauan government to issue bonds to individual investors and efficiently manage principal and interest payments, according to the report.

The total cost of the project is estimated at several hundred million yen ($1.2 million to $5.6 million), less than half the cost of a non-blockchain alternative, people familiar with the matter said. The project has reportedly received support from Japan’s Ministry of Economy, Trade and Industry, with Japan’s foreign and finance ministries providing strategic and management advice on the project.

Soramitsu’s successful development of Cambodia’s CBDC in 2020 has boosted its reputation, with the digital currency’s popularity soaring, with over 10 million accounts opened by December 2023, representing 60% of Cambodia’s population. Following this, Cambodia’s central bank governor Chea Serey indicated intends to expand the reach of its CBDC internationally, particularly through collaboration with UnionPay International, the Chinese card payment service, and other global partners.

While Soramitsu’s work in Cambodia has been well received, the long-term popularity of CBDCs remains to be seen. As of late June, crypto.news reported a sharp drop in activity in India’s digital currency, the e-rupee, after local banks stopped artificially inflating its values.

According to people familiar with the matter, the Reserve Bank of India managed to hit the 1 million retail transaction milestone last December only after the metrics were artificially infiltrated by local banks, which offered incentives to retail users and paid a portion of the bank’s employees’ salaries using the digital currency.

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