Imagine a future in which anybody could design transparent, equitable, and effective financial products, driving banks, major lenders, insurers, and other financial institutions into the background—or, better still, making them entirely worthless and disappearing altogether. But also a society in which everyone can freely use these services. This is where the decentralized financial system comes into play.
Decentralized finance, or DeFi for short, is an alternative to the conventional financial system that is old, restricted, and heavily centralized. DeFi is both global and transparent, and that’s why people are turning to it more and more.
The world of decentralized money is enormous. And this is just the beginning. Discover what DeFi is, its benefits, and how it works.
What is DeFi or Decentralized Finance?
A system known as decentralized finance or “DeFi,” makes financial transactions accessible on a public decentralized blockchain network. Transactions only occur on a peer-to-peer basis rather than through intermediaries like banks or brokers. DeFi is a technique through which blockchain-based software permits communication between parties directly rather than through a business or organization that facilitates the transaction. DeFi conducts business using smart contracts rather than intermediaries.
Blockchain supporters favor using decentralized finance to manage their money. The main goal behind the decentralized finance concept is to make it possible for everyone with a smartphone and an internet connection to save, exchange, lend, invest, or get insurance.
How Does DeFi Work?
So, DeFi wants to replace our present centralized financial systems with decentralized systems. DeFi is based on smart contracts within a blockchain where every action taken is presented with a transparent and unchangeable string.
Though it is still in its infancy, practically every financial product is already being transformed by the ingenuity of the global community.
Consider that you need to get a business loan. You can apply for a loan through a DeFi platform rather than visiting a bank. The loan terms are pretty plain and unambiguous, all because the loan in question will be managed via a transparent and unchangeable smart contract.
All acts taken on the platforms are public and immutably recorded on the blockchain. Although you could lack the expertise to evaluate the DeFi service’s reliability, thousands of eyes will be able to examine it and tell you if there are any problems as a result of its transparency feature.
You won’t need to go to the bank, carry paperwork, stand in line to submit them, or wait weeks for a response. Instead, you can complete the whole transaction with the cash in your hands while relaxing on your sofa and using your smartphone.
However, DeFi can be much more than that. It can be how the economics and finances of this more contemporary world are carried out. DeFi can be the mechanism that opens doors to international investment without as much bureaucracy, cost, and time and with higher levels of trust and transparency. A way for people who don’t have access to bank services without the dictatorships of banks, having the same conditions to evolve personally.
Centralized vs. Decentralized Finance?
In the context of finance, the term “centralization” refers to a point of central control, namely banking institutions. In the past, centralization of finance was seen as beneficial, since it was regarded to be more safe and stable than personal administration, and would help preserve stability in global financial systems. Alas, this kind of system is constantly bringing problems like frauds, forgeries, etc. Although the centralized finance of CeFi is a dominant financial system, some think it’s time to be replaced with something more secure.
Decentralized finance, or DeFi, offers several improvements to the widespread financial systems in use today. It enables users to conduct financial transactions over a blockchain network. As a result, intermediaries like established financial organizations are cut out.
Eliminating intermediaries subsequently lowers costs and speeds up processes. Decentralized finance also makes it much easier to get financial services.
Not all people are eligible to create bank accounts or have access to certain financial services in centralized finance. DeFi consequently seeks to provide economic empowerment to several billion individuals worldwide.
DeFi Use Cases
Lending and Borrowing
With DeFi lending, individuals can borrow money via the network and repay the borrowed money and interest before a specific date. Investors can deposit money through a decentralized application and receive interest. Since the loan is executed via smart contracts, as was previously explained, intermediaries are not required. Using a smart contract removes the need for extra fees related to borrowing money. As a result, applying for a loan via DeFi is significantly quicker than going through a conventional financial institution since the lengthy administration process time is eliminated. With peer-to-peer lending, borrowers can receive loans at rates lower than what they would pay to a bank, while long-term investors can profit from the loan’s interest.
Stable Coins or Stable Currencies
Because they are linked to other assets like fiat currency (which is often tied to the dollar), exchange-traded commodities, or other cryptocurrencies, stablecoins are a kind of cryptocurrency whose value is stable. Considering how unstable cryptocurrencies like Bitcoin and Ether are right now, stablecoins provide a more secure alternative for lending, decentralized insurance, quicker and less expensive international transactions, and exchanging goods and services. Everyone knows that when a nation’s economy falters, its fiat value drops, raising concerns about the stability of stablecoins, 90% of which are pegged to the value of fiat money. As a result, more and more people are turning to algorithmic stablecoins.
Decentralized Exchanges (DEX)
Decentralized exchanges are marketplaces for cryptocurrencies that link buyers and sellers by enabling peer-to-peer commerce. They let you trade multiple cryptocurrencies, but you can’t acquire digital assets with fiat money, trade fiat, or withdraw cash from decentralized exchanges straight to your bank account. Lack of intermediaries, protection against market manipulation, and anonymity are only a few benefits of DEX. Compared to centralized exchanges, they also provide quicker and less expensive transactions.
Derivatives
In decentralized finance, derivatives are contracts whose values are based on how well the underlying financial asset performs. These fundamental assets include commodities, equities, interest rates, bonds, currencies, market indexes, and other financial instruments. The main distinction between DeFi and CeFi derivatives is that anybody can construct a contract linked to an asset on the DeFi derivatives market. Still, a CeFi derivative can only be formed by a central authority. Users do not have to provide identification or eligibility documentation since there is no centralized authority, making DeFi derivatives more widely available.
Margin Trading
DeFi trading also permits increasing a holding in an asset using borrowed money. The exchanged financial asset serves as loan collateral. Leverage and shorting are the two significant elements of margin trading. A trader uses “leverage” when he borrows money to expand the number of assets they are trading. When a trader borrows money to sell an asset, expecting its value to fall, this is known as “shorting”.
Insurance
An element of centralized funding called insurance is also a part of the decentralized ecosystem. It operates on the well-known tenet that compensations are given in return for a premium. Insurance is often utilized in DeFi to safeguard deposits and guard against smart contract cancellation.
Benefits of DeFi
Transparency
DeFi operates completely transparently since other users confirm all transactions.
Previously mentioned implies that everyone has simultaneous access to all of these transactions. This enables users to conduct sophisticated data analyses without any mutually beneficial advantages.
On the other hand, because each user uses an encrypted address with keys or passwords, complete secrecy is retained.
No Authorization Is Necessary
The proper term for this benefit is “permissionless” and denotes that a middleman isn’t required to conduct transactions.
The only thing user need to make transactions is to have internet access and a cryptocurrency.
Immutability
Complete security must be guaranteed for the system to function. The security must be at the level of hand-to-hand goods trading.
With blockchain, this is achieved with cutting-edge data transfer protocols that guarantee transactions are unique and immutable.
Programmability
The system can be fully coded, enabling all possible automation, which is essential in the Ethereum environment, a blockchain that is now essential in the DeFi environment and is specialized explicitly for these tasks.
Not Custodial
We handle custody for DeFi transactions in our digital wallet.
In conventional finance, we need other businesses like banks, insurance firms, loan entities, dealers, etc.
Once again, DeFi gets us closer to prehistoric banking, when we physically held the money in our pockets.
Interoperability
Regardless of the blockchain technology they utilize, protocols and apps may be interconnected.
Because there are no restrictions, it is a system that offers creators the most significant amount of freedom, which also means that potential is maximized.
Conclusion
Decentralized finance, or DeFi, eliminates intermediaries in financial transactions using emerging technologies. It utilizes similar technologies to cryptocurrencies.
DeFi’s primary goal is to circumvent regulatory agencies so that transactions can be completed more quickly, safely, and affordably. Significant risks include the volatility of the employed currencies and the potential for fraud. The decentralized financial system is just getting started. Therefore, DeFi infrastructure and legislation are still being developed and discussed.
