What is decentralized finance (DeFi)?

A smart contract is a computer program or set of codes capable of automatically executing contractual terms. In other words, it is a digital contract written in computer code that executes and enforces agreed-upon conditions as soon as predetermined criteria are met. It enables the fulfillment of contractual obligations without the need for manual intervention or intermediaries. A smart contract can facilitate various transactions, such as transferring crypto-assets, distributing earnings, or managing asset ownership.

For instance, if a user borrows a crypto-asset, the smart contract automatically releases the borrowed sum, monitors repayments, and enforces repayment if necessary.

A smart contract is recorded on the blockchain, making it transparent and immutable, which increases trust between contracting parties.

Smart contracts are used in various sectors, from financial services to supply chains. In the insurance sector, for example, smart contracts can automatically process claims payments once predefined conditions, such as claim verification, are met. In real estate, these contracts can automate processes such as rent collection.

Users can borrow various crypto-assets without relying on traditional financial institutions. Likewise, they can lend their crypto-assets to other counterparties and earn interest.

Enable users to trade crypto-assets directly with one another without a centralized provider.

Users can earn passive income by depositing their crypto-assets into DeFi protocols in exchange for interest paid in the respective crypto-asset.

Provides protection against various risks through smart contract mechanisms, as described earlier.

DeFi simplifies access to services such as investments and loans for individuals who lack access to traditional financial institutions.

DeFi enables new financial products and services that have the potential to transform the financial system.

DeFi poses challenges to traditional regulatory frameworks since it operates outside traditional financial institutions.

DeFi protocols can be vulnerable to technical failures and cyberattacks, which, if the sector were to grow significantly, could impact financial stability.