What is Defi? All you need to know

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    The trend known as DeFi, or Decentralized Finance, is taking the blockchain world by storm. As you can see from the chart above, the total amount invested (or “locked”) in DeFi is about $7.5 billion, up from just over $1 billion in June. This is either a blockchain breakthrough, or a blockchain bubble. (Turns out, it's both.)

    This week I went in deep into DeFi. My goal was to see if there’s real value there, and to understand why people have bet $7.5 billion on its future. Is DeFi worth the investment? Read on to find out what I learned.

    What the DeFi

    At a high level, DeFi (or Decentralized Finance) is a set of websites and apps where digital assets (like Ethereum) can be used to create new financial products like loans, index funds, and derivatives. That’s a mouthful to explain, so here's a simple example.

    In a traditional bank, let’s say you want to take out a loan to start out a new business. Applying for this loan will require hours of time and mountains of paperwork. You might have to put up your house as collateral – if you can’t pay back the loan, in other words, the bank can take your house. If you’re approved, the bank gives you the money, then you gradually pay back this loan (with interest).

    This is what we call traditional or centralized finance – it’s managed by a central institution (a bank), which itself reports to a bigger central instituion -- what we literally call the “Central Bank."

    With a decentralized loan, this model gets flipped on its head: you're borrowing not from banks, but from other users. You buy digital assets (like Ethereum), then use simple, one-click apps like Compound to take out a loan, using that Ethereum as collateral. Behind the scenes, the app finds lenders -- not banks, but other investors who are earning interest by lending to you.

    If you can’t pay back the loan – or the price of your original Ethereum drops suddenly – the app will sell your original Ethereum (just as the bank might seize your house). This is one reason DeFi apps are incredibly risky, and you should be prepared to lose 100% of your investment.

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