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Concept
Decentralized finance
Summary
Decentralized finance (often stylized as DeFi) offers financial instruments without relying on intermediaries such as brokerages, exchanges, or banks by using smart contracts on a blockchain, mainly Ethereum. DeFi platforms allow people to lend or borrow funds from others, speculate on price movements on assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts. DeFi uses a layered architecture and highly composable building blocks. Some applications promote high interest rates but are subject to high risk. Coding errors and hacks have been common in DeFi.
Decentralized exchanges (abbreviated DEXs) are alternative payment ecosystems with new protocols for financial transactions that emerged within the framework of decentralized finance, which is part of blockchain technology and fintech.
CEXs (centralized exchanges), DEXs and DEX aggregators are all built on the multi-layered DeFi architecture or components, where each layer serves a well-defined purpose. (See Figure: Multi-layered Architecture of the DeFi Stack).
While they share common components of the first four layers, such as Settlement layer, Asset layer, Protocol layer and Application layer, DEX aggregators have an additional component or Aggregator layer, which allows them to connect and interact with other DEXs via smart contracts.
The Ethereum blockchain popularized smart contracts, which are the basis of DeFi, in 2017. Other blockchains have since implemented smart contracts.
MakerDAO is a prominent lending DeFi platform based on a stablecoin that was established in 2017. It allows users to borrow DAI, a token pegged to the US dollar. Through a set of smart contracts that govern the loan, repayment, and liquidation processes, MakerDAO aims to maintain the stable value of DAI in a decentralized and autonomous manner.
In June 2020, Compound Finance, a decentralized finance protocol enabling users to lend or borrow cryptocurrency assets and which provides typical interest payments to lenders, started rewarding lenders and borrowers with a cryptocurrency called Comp.
Official source
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