The financial sector is all abuzz with decentralized finance, or DeFi.
According to a wide range of industry observers, market experts, and institutional investors, DeFi is the next big thing to disrupt the financial system and force the big banks to adapt or perish.
But while all eyes are on DeFi, the next question many might have been if it also coincides with cryptocurrency. The answer is that the two complement one another, and crypto plays a large role in DeFi – and vice versa.
So, what is DeFi crypto all about? Let’s explore!
First, DeFi is financial technology based on secure distributed ledgers like those used by cryptocurrencies. Banks and brokerages are centralized financial institutions. They hold money for consumers and then facilitate the movement of this money between different parties. DeFi challenges this concept and promotes the empowerment of individuals with peer-to-peer digital exchanges. It enables individuals, merchants, and businesses to conduct financial transactions through emerging technology. DeFi also eliminates the fees banks and other financial institutions charge for their services. Under DeFi, people hold money in a digital wallet that is secure and that allows users to transfer their funds within minutes. Anyone with an internet connection can use DeFi.
Second, many cryptocurrencies are produced and named for DeFi networks and apps, such as AAVE, Chainlink, Compound, Maker, and Uniswap.
DeFi is accessible to anyone using Ethereum, the world’s second-largest cryptocurrency platform. The core components of DeFi include stable coins, software, and hardware. Users can lend, trade, and borrow using software that records and verifies their financial actions in a distributed database. Market participants can also earn interest, buy insurance, trade derivatives, trade assets, and more.
This database is accessible across different locations and collects and aggregates data using a consensus mechanism for verification. The DeFi model eliminates the need for centralized finance, enabling everyone to use financial services anywhere. DeFi gives users more control over their money. Markets are always open, and there are no centralized authorities that could block payments or deny access to users. It is advanced technology; hence all services are automatic and handled by code.
DeFi uses blockchain technology. A blockchain is a distributed database or ledge. Decentralized Applications (dApps) are used to handle financial transactions and run blockchains. The most popular applications include decentralized exchanges (DEXs), stablecoins, lending platforms, wrapped bitcoins (WBTC), and prediction markets. DeFi concepts are also being applied to yield farming, liquidity mining, composability, and money legos.
All transactions are recorded in blocks and verified by other users. If the verifiers approve the transaction, the block is closed and encrypted. Another block is created with the information within it. All blocks are chained together with information in proceeding blocks, hence the name blockchain. No information can be changed in the previous blocks without affecting the following blocks. A blockchain cannot be altered. This characteristic makes blockchains very secure.
Transactions on the DeFi platform are known as smart contracts. They are automatically executed once conditions are met, and programming languages, such as Solidity, create and deploy these contracts.
DeFi offers several benefits:
· Greater accessibility: Anyone with an internet connection can access a DeFi platform. Also, transactions can occur anywhere without geographic limitations or restrictions.
· Open: The system is completely open. Users do not have to apply for anything or open an official account. They get access to a wallet.
· Low fees: DeFi does not charge any fees for its services, unlike banks and other financial institutions.
· High interest rates: DeFi allows two parties to negotiate interest rates and lend money using the DeFi networks.
· Security: Information is saved on a blockchain, and records of all completed transactions are available. However, no identity is revealed, and the information in the blockchain cannot be changed. Also, users do not have to provide personal information, including their names or email addresses.
· Flexibility: DeFi provides excellent accessibility to users allowing them to move their assets anywhere at any time without asking for more information, permission, long waiting times
· Autonomy: DeFi does not rely on a centralized system; therefore, there is no reliance on a “middleman”.
Like every product or service, DeFi has some disadvantages. First, participation in DeFi can be fairly complex, and it is not understood by everyone. There is also a high risk of fraud and scams over this network, along with a high level of volatility. Also, the infrastructure and regulation of DeFi are still evolving. The area is fairly unregulated, so there is an increased risk of mishaps and hacks. DeFi does not provide users full anonymity. While transactions do not include individual names, this information is traceable by entities with access, such as governments and the law. Fluctuating transaction rates on the blockchain can make trading expensive.
DeFi, cryptocurrencies, DApps, Blockchains, and everything else in this arena are new technologies, so it is only natural that they will experience high volatility and uncertainty. Still, the future for these emerging technologies is exciting.