Decentralized finance, commonly known as DeFi, is a financial technology that uses decentralized, distributed ledgers known as blockchains to verify and execute transactions without using a financial intermediary.
DeFi refers to any transaction or exchange that utilizes cryptocurrencies and tokens. Examples of DeFi include decentralized cryptocurrency exchanges, digital asset marketplaces for assets like NFTs, and decentralized eCommerce websites.
DeFi removes third-party, centralized institutions from financial transactions to provide widespread access to banking and financial accounts without paying transaction fees or requiring extensive documentation to open an account. This way, DeFi is able to provide financial freedom to individuals located in third-world countries without access to traditional institutions. It also provides a censorship-resistant alternative to traditional banking solutions. While DeFi might sound insecure or unreliable, it's actually highly secure and incredibly reliable, thanks to blockchain networks.
How DeFi Works
DeFi uses blockchain networks to validate and execute transactions. When a transaction is submitted to a DeFi platform, whether it be a decentralized exchange or a simple transfer between wallets, the transaction is submitted to the blockchain's network of nodes. Blockchains use a pool of validator nodes to achieve network consensus, a process which verifies that the submitted transaction is valid and legitimate. Once validated, the transaction is recorded into a block along with other transactions and a record of the block that came before it. This creates a chain of blocks that are linked together, since each block contains info about the block directly before it.
Blockchains are permanent, immutable ledgers. Once a block has been written to the chain, it cannot be removed or changed. If blockchains were mutable, they wouldn’t be able to be trusted for executing financial transactions without a center intermediary. Only due to their immutable nature have they been able to facilitate DeFi functionality.
Benefits of DeFi
DeFi has gained widespread traction across the globe not only due to its immutable nature but for other important reasons such as:
- Accessibility: Creating a crypto wallet to send and receive crypto payments is a form of DeFi, and can be done by anyone without needing to verify your identity, make a deposit, or pay a fee.
- Low fees: DeFi transactions have low transaction fees compared to traditional centralized finance, and investing in various DeFi technologies like liquidity pools.
- Transparency: The record of all transactions on a blockchain network is publicly accessible, providing a level of transparency that can be verified by anyone.
- Autonomy: DeFi platforms don’t rely on centralized middlemen to approve transactions, and aren’t subjected to risks that traditional financial intermediaries are, like bankruptcy or adversity.
Who Uses DeFi?
The beauty of DeFi is that it can be used by anyone in the world. Creating a crypto wallet and connecting it to a DeFi app or platform can be achieved by anyone. Currently, the most common users of DeFi include:
- NFT collectors and creators.
- Cryptocurrency investors.
- Personnel who don’t have access to traditional banking solutions.
How Does DeFi Use IPFS?
For DeFi to truly be decentralized, it needs to use decentralized storage. Storing data on a centralized provider, like AWS, doesn’t support the DeFi attributes of transparency and decentralization. Data stored on centralized storage providers can be used for advertising or other unsolicited purposes, and is susceptible to outages due to its several single points of failure.
IPFS, or InterPlanetary File System, is a decentralized communication protocol that is used to facilitate the functionality of the IPFS network. Through the IPFS protocol, nodes around the world are connected to a decentralized peer-to-peer network that is used for file storage. This form of file storage uses content addressing, which is a manner of file retrieval that uses a content identifier rather than the file’s location on a web server.
IPFS is a popular solution for DeFi applications to store or host data, since all data stored on IPFS can be accessed publicly through the file’s content identifier, and things like link rot aren’t a concern. This provides a reliable and persistent data storage solution that isn't susceptible to outages due to the network's decentralized nature.
While it’s clear that DeFi uses decentralized blockchain peer-to-peer networks for transaction execution, how can DeFi utilize IPFS today?
- Decentralized eCommerce platforms can store product listing information like images, metadata, and transaction history off-chain on IPFS to minimize the amount of data they store on blockchains like Ethereum or Polygon.
- Digital asset collections like NFT collections often use IPFS to store NFT images and their associated metadata files.
- Decentralized applications that serve a decentralized finance function like a decentralized exchange app can be stored and deployed on IPFS, then accessed in a web browser using the application’s content identifier and an IPFS gateway.
- Decentralized exchanges can store a record of their transaction history on IPFS as a secondary backup of all actions on their platform that can be easily referenced or parsed through.
- Decentralized autonomous organization (DAO) voting and governance can use IPFS to store organization change proposals, such as how to distribute and spend DAO treasury funds. All votes for the proposal can be persisted off-chain on IPFS instead of being stored on-chain.
Building DeFi with IPFS on Filebase
Filebase is a decentralized storage and geo-redundant IPFS pinning service. All files stored in an IPFS bucket on Filebase are pinned to the network with 3x redundancy across diverse geographic locations in the United States, London, and Germany. The term ‘pinning’ refers to storing data on an IPFS node for long-term data persistence that isn’t at risk of being removed by the automatic resource allocation process known as IPFS garbage collection.
A few use-cases of using DeFi with IPFS on Filebase include:
- Creating a decentralized ecommerce website with DeCommerce that’s hosted on IPFS.
- Building a decentralized app that tracks Ethereum transactions for your crypto wallet.
- Creating a DeFi app on the Agoric network.
- Deploying an NFT marketplace app with thirdweb and Filebase.
You can sign up for a free Filebase account to get started with your IPFS journey today.