DeFi (decentralized finance) puts Digital Money to work. DeFi developers are implementing both old and new financial tools that use digital money instead of traditional fiat. A number of things make DeFi products superior to the same products that exist in traditional finance:
- Composability + iteroperability of DeFi products
- Ability to self-custody your own financial instruments
- No middle-men
- Low fees
- High throughput
Lending + Borrowing
Suppose I have $10,000 USD sitting in my bank account. There I earn 0.15% interest on that princial which is $15 per year. With DeFi I could instead lend this money out while taking on minimal risk and receive something like 20% APY on that principal which comes out to $2000 per year. As a lender it's clear which option I would prefer.
On the other side if I would like to borrow against my assets DeFi makes this extremely easy too. One could put down 1 Bitcoin as collateral and borrow up to 60% of its value in US dollars. So if 1 Bitcoin is worth $100,000 then one could borrow up to $60,000 on that collateral. If the value of my underwriting collateral (here, Bitcoin) drops such that my loan-to-value is over 60% then my Bitcoin will be liquidated and the proceeds from the sale used to cover my debt, thereby keeping the lender-borrower system solvent.
Borrowing against assets like this is similar to taking a home equity line-of-credit (HELOC) in TradFi except here I borrow only against digital assets on a blockchain and, because the system builds on programmable money, it is entirely automated by a smart-contract and is a far more efficient use of capital + time.
Composability
In addition to being efficient DeFi products are also composable. All products in an ecosystem have access to the same underlying blockchain so one product may make use of the financial tools created by another product. The possibilities of any DeFi product are really only bound by the imaginations of its developers.
For example the 20% APY I'm earning on my $10,000 could be used to secure a payments on another loan (self-repaying loans), or I could build further on that 20% APY to automatically invest on my behalf into another asset. There are many such products building on Terra Anchor
Finally with exciting technologies like Cosmos' Inter-blockchain Communication (IBC) even DeFi products running on different blockchains can use assets from the other connected chains. I believe the cross-blockchain composability of DeFi will be an important area to watch in the coming years. Even now we are beginning to see things like Thorchain, a decentralized cross-chain liquidity network providing swaps between native assets without the need for wrapping, which I can easily see becoming one of if not the building-block for the cross-chain DeFi products of the future.