What Is DeFi and How Does It Work?

Decentralizedfinance (DeFi) is one of the most exciting modern applications of blockchain technology. Learn more about its importance and how it differs from traditional finance.

What is DeFi?

DeFi is an anonymous system that completes traditional financial transactions without any use of, or interference from, an intermediary or governing body. Instead of using a neutral third party, DeFi uses an application through blockchain technology, also known as DeFi protocol, to connect users directly; its products and smart contracts maintain the fulfillment of these agreements. While it’s possible to build DeFi apps on other blockchains, Ethereum is the most popular and accessible in 2021.

What is a smart contract?

Smart contracts make it possible for users to create DeFi apps on top of the blockchain; they’re transactional protocols or computer programs that automatically execute when relevant events tied to the agreement take place. Ethereum is closely related to DeFi because it was coded with smart contracts in mind.

Why is DeFi important?

A societal transition away from traditional finance toward DeFi would constitute a fundamental shift in the ways we interact with forms of currency.

There are often dozens of third parties involved in your finances. We store fiat currency with financial institutions. We go through traditional banks and exchanges to digitally transfer fiat currency to friends and family. These processes can be time-consuming, and potentially expensive to utilize as they often involve transaction fees.

How does DeFi differ from traditional finance?

Traditional finance is highly regulated, and there’s often a frequent amount of fees. While we have a greater familiarity with traditional finance, DeFi offers:

Much higher levels of autonomy with transactions; no permissions are needed to conduct transactions and deals can be structured without waiting periods

Better transparency into transactions and fees
Greater trust in the technology itself as opposed to intermediaries like banking institutions

What are DeFi applications?

Decentralized finance already includes dozens of different financial applications, and more will inevitably develop in the years to come. After all, the only limit to what DeFi could accomplish is how well the smart contract is crafted.

Some of the most significant modern DeFi services and decentralized applications are:

Coins
Stablecoins
Tokens
Wallets
Liquidity, mining, and staking
Trading
Borrowing, lending, and saving

What are the tax implications of DeFi?

You can generate two types of taxable income: ordinary income and capital gains. For example, earning crypto through a DeFi exchange for services rendered is ordinary income. Trading one crypto for another through a DeFi exchange could be a capital gains tax event and generate a capital gain if the proceeds exceed the cost basis.

How TaxBit can help

TaxBit recognizes the need to support your DeFi activity, and each day we're actively working on expanding DeFi support to popular blockchains.

The initial version of our Defi support allows you to sync in any transfers, trades, and approvals you’ve made on a DeFi platform involving ERC-20 tokens on the Ethereum network, or BEP-20 tokens on the Binance Smart Chain network.

To know more, contact us at: https://www.codezeros.com/contact

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