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 digital exchanges.

DeFi eliminates the fees that banks and other financial companies charge for using their services. Individuals hold money in a secure digital wallet, can transfer funds in minutes, and anyone with an internet connection can use DeFi.

Centralized Finance

In centralized finance, money is held by banks and third parties who facilitate money movement between parties, with each charging fees for using their services. A credit card charge starts from the merchant and moves to an acquiring bank, which forwards the card details to the credit card network.

The network clears the charge and requests a payment from the bank. Each entity in the chain receives payment for its services, generally because merchants must pay for the use of credit and debit cards.

All financial transactions are overseen in centralized finance, from loan applications to a local bank's services.

Decentralized Finance

Decentralized finance eliminates intermediaries by allowing people, merchants, and businesses to conduct financial transactions through emerging technology. Through peer-to-peer financial networks, DeFi uses security protocols, connectivity, software, and hardware advancements.

Wherever there is an internet connection, individuals can lend, trade, and borrow using software that records and verifies financial actions in distributed financial databases. A distributed database is accessible across various locations as it collects and aggregates data from all users and uses a consensus mechanism to verify it.

Decentralized finance eliminates the need for a centralized finance model by enabling anyone to use financial services anywhere regardless of who or where they are. DeFi applications give users more control over their money through personal wallets and trading services that cater to individuals.

How Does DeFi Work?

Decentralized finance uses the blockchain technology that cryptocurrencies use. A blockchain is a distributed and secured database or ledger. Applications called dApps are used to handle transactions and run the blockchain.

In the blockchain, transactions are recorded in blocks and then verified by other users. When verifiers agree on a transaction, the block is closed and encrypted; another block is created that has information about the previous block within it.

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.

Uses of DeFi

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

In DeFi, P2P can meet an individual's loan needs, and an algorithm would match peers that agree on the lender's terms, and a loan is issued. Payments from P2P are made via a decentralized application, or dApp, and follow the same process in the blockchain.

Using DeFi allows for:

- Autonomy:
DeFi platforms don't rely on any centralized financial institutions and are not subject to adversity or bankruptcy. The decentralized nature of DeFi protocols mitigates much of this risk.

- Accessibility:
Anyone with an internet connection can access a DeFi platform and transactions occur without any geographic restriction.

- Low fees and high-interest rates:
DeFi enable any two parties to directly negotiate interest rates and lend money via DeFi networks.

Decentralized applications allow individuals to transfer capital around the world.

Investor's ability to generate income.

High level of security.

Instant execution of orders. ( e.g. Arbitrage, OTC, HFT, etc.)

What Is Proof-of-Stake (PoS)?

Proof-of-stake is a cryptocurrency consensus mechanism for processing transactions and creating new blocks in a blockchain. A consensus mechanism is a method for validating entries into a distributed database and keeping the database secure. In the case of cryptocurrency, the database is called a blockchain—so the consensus mechanism secures the blockchain. Validators are selected randomly to confirm transactions and validate block information. This system randomizes who gets to collect fees rather than using a competitive rewards-based mechanism like proof-of-work. To become a validator, a coin owner must "stake" a specific amount of coins. For example,Ethereum requires 32 ETH to be staked before a user can become a validator.

• With proof-of-stake (POS), cryptocurrency owners validate block transactions based on the number of staked coins.
• Proof-of-stake (POS) was created as an alternative to Proof-of-work (POW), the original consensus mechanism used to validate a blockchain and add new blocks.
• While PoW mechanisms require miners to solve cryptographic puzzles, PoS mechanisms require validators to hold and stake tokens for the privilege of earning transaction fees.
• Proof-of-stake (POS) is seen as not risky regarding the potential for an attack on the network, as it structures compensation in a way that makes an attack less advantageous.
• The next block writer on the blockchain is selected at random, with higher odds being assigned to nodes with larger stake positions.

How Do You Earn Proof-of-Stake?

Proof of Stake (POS) is a built-in consensus mechanism used by a blockchain network. You can help secure a network and earn rewards by using a cryptocurrency client that participates in PoS validating or becoming a validator.

How Is Proof-of-Stake Different From Proof-of-Work?

Both consensus mechanisms help blockchains synchronize data, validate information, and process transactions. Each method has proven to be successful at maintaining a blockchain, although each has pros and cons. However, the two algorithms have very differing approaches. Under PoS, block creators are called validators. A validator checks transactions, verifies activity, votes on outcomes, and maintains records. Under PoW, block creators are called miners. Miners work to solve for the hash, a cryptographic number, to verify transactions. In return for solving the hash, they are rewarded with a coin. To "buy into" the position of becoming a block creator, you need only own enough coins or tokens to become a validator on a PoS blockchain. For PoW, miners must invest in processing equipment and incur hefty energy charges to power the machines attempting to solve the computations. The equipment and energy costs under PoW mechanisms are expensive, limiting access to mining and strengthening the security of the blockchain. PoS blockchains reduce the amount of processing power needed to validate block information and transactions. The mechanism also lowers network congestion and removes the rewards-based incentive PoW blockchains have.

Proof of stake	Proof of work
Block creators are called validations	Block creators are called miners
Participans must own coins or tokens to become a validator	Particioants must buy equipment and energy to become a miner
Energy efficient	Not energy efficient
Security through community control	Rebust security due to expensive requirement
Validator receive transactions fees as rewards	Miners receive block rewards