A new era is being established in the finance sector all across the globe. DeFi is getting popular every passing day and it’s the right time you find out what it is. Here we have provided you with a short synopsis of Decentralized Finance (DeFi) and covered its importance & benefits in the finance sector. So, let’s begin with understanding what Decentralized Finance is.
What is Decentralized Finance?
Decentralized Finance or DeFi as it is commonly known as in today’s world, is a new internet age finance system, where all services are peer-to-peer through a public blockchain network, with no hassle of middle authority for each transaction approvals. This helps in completely decentralizing the control of the finances to the users. Unlike in traditional decades old centralized financial services where the control is with central authority with many flaws and high chances of mistakes.
As the cryptocurrencies have seen a major success in recent years, Decentralized Finance is a new beginning. With DeFi it is possible to lend, borrow ,invest, earn interest, trade assets and much more just like in conventional finance banking but without any intervention or human errors. Now, who wouldn’t like it ? Everything is automated, programmed and open source so that anyone can keep a check and scrutinize the same. Since all the records are on blockchain forever available for the public, lending a high level of transparency and faster transactions. This is again in the favour of the users and makes it a viable option.
What is the Significance of DeFi ?
With the traditional financial system which is opaque, highly controlled and still follows the ancient processes and infrastructure. Most importantly, primarily it is well known that each country has their own financial service rules in place, which makes it very difficult to perform satisfactory financial transactions benefiting either of the parties. To break this centralized authority and all the imperfections associated with it we need a more open, free and pursue a fair financial system which is easily accessible to everyone.
So basically DeFi wants to create a new infrastructure to provide similar financial services and products just like in traditional financial systems but by decentralizing all the aspects. Removing the central authority altogether brings a peer-to-peer service platform on the blockchain network which is useful.
To build on what cryptocurrencies have achieved over the years, DeFi strives to go bigger and better. To enhance all the benefits of the crypto space by building an entire modern financial system which is open, fair and provides secure & faster services across the globe.
How does the DeFi work?
With the introduction, we have already established that DeFi works mainly on blockchain networks as smart contracts and uses cryptocurrencies to provide services that don’t need any authorities permission or deny to be completed. The main agenda of DeFi is to provide all types of financial services just like traditional systems do such as loans, interest on deposits, payments etc but by using a decentralized platform.
So smart contracts which are executable codes containing cryptocurrency, interact with blockchain according to the specified rules. So that these smart contracts can be programmed to perform any specified rules such as transfer a set amount of money from Account A to Account B on a pre-set date until set Time period. And this smart contract will be executed without any delay or interruption until Account A will have the required funds available for the time period. Importantly, Smart contracts are also public for anyone to look at and audit, which means it can be scrutinized by anyone making it a transparent and functional system.
Now, to engage with DeFi, dApps (decentralized apps) are used which can be installed on your smartphones and don’t need to fill out applications to operate. All you need is to link your crypto wallets to the dApps and they are good to go. Let’s take a look at the various financial products provided by DeFi which are as follows –
- Loan – Getting loan sanction is much easier now without any paperwork filling or wait period. It is instantly obtained with short term “flash loans “.
- Trading – Since it is peer-to-peer , trading crypto assets is direct and has no brokerage fees.
- Save – You can just put your crypto into a savings account and earn better interest rates.
- Lending – It’s easy to lend your crypto and make a decent interest and rewards.
- Investing in derivatives – Purchase either short or long term bets on certain assets.
What are the Benefits of DeFi ?
Compared to the old age traditional financial systems, DeFi or Decentralized Finance provides significant advantages mainly with respect to the transparency and complete control over your assets. In traditional financial system everything is highly centralized, inefficient and low security, to counter the same DeFi provides excellent list of benefits such as following :
- Transparent – All transitions are open to see for everyone. Everything is open to scrutiny on the public blockchain network and permanently available forever. Each and every transfer and transaction can be overseen by all and hence the paramount transparency.
- Open platform – Create a crypto wallet and no need to apply or open an account. With decentralizing every aspect, there is no central authority to apply for permission or create an account.
- Financial Freedom – Most products on DeFi will never take custody of your assets, hence complete control is in your hands. Since there is no middle man or central authority, each asset is under your control to move around or trade.
- Pseudonymous – No need to share personal information, no KYC. Considering DeFi is on a public blockchain, no permission is required hence no need to share your personal information and thus improves the security significantly.
- Flexible – NO asking for permission, waiting for transfers and paying fees to move your assets or for any transactions. No service charges or fees.
- Fast – Extremely fast updates compared to traditional financial services. Each transaction is from peer-to-peer and on a blockchain network, thus providing faster interest rate updates and transactions.
What are the Risks of DeFi ?
DeFi is a niche and budding system which needs to be accepted and enriched for the coming days. The concept is widely acceptable but the implementation might take up a considerable amount of scrutiny to come to terms world wide. Although DeFi is an upcoming refined financial system, it does present various drawbacks and considerable risks to adopt as of now. But to keep our readers informed in all aspects, we have listed out the risks for you. Following are few of the risks related to DeFi :
- Complexity – For beginners who are getting into crypto space it might be a bit of a learning curve initially. Compared to just going down the bank to create an account here, selecting the right DeFi apps and a non-custodial wallet and setting up all that will be a bit of initial work.
- Fluctuations – With fluctuating cryptocurrency valuations it is sometimes unpredictable for Fluctuating transaction rates on Ethereum blockchain – active trading can get expensive.
- Volatility – Considering it is still in the infancy stage of development, new adopters have to deal with highly volatile new technology and new products like dApps.
- Scams & Theft – The Internet is filled with scams and hackers constantly looking for loopholes to take advantage. Although blockchain is among the most secure networks, sometimes it gets unnerved to constantly be careful with right choices and security.
- Costs – Compared to traditional service charges in DeFi the real fees are to be paid as gas fee for interacting with smart contracts.
- Self management – Maintain and manage own records for tax purposes, unlike in traditional services where the bank will take care and charge a premium for the same.
These are the few of the risks in adopting DeFi and need to be considered by you before fully committing yourself.
Think of DeFi is the following layers simplified :
- The Blockchain – A ledger which contains complete transactions history and state of accounts.
- The Assets – Various cryptocurrency and digital assets
- The Protocols – Smart Contracts : Executes the specified rules and functionality.
- The Applications – dApps : products used to manage and access the protocols.
From the look of how Cryptocurrency and digital assets like NFTs have been expanding rapidly in recent years it is quite evident that DeFi futures looks to be very bright and prosperous. Even though DeFi is in its infancy state and yet many things are at risk to get into. But the large number of advantages it provides compared to the traditional finance system such as high transparency, zero hassle with permissions and costs, full control over your money and potential to open up the market makes it a viable option to consider and invest.