Decentralized Finance (DeFi), is the name given to a major trend centered on blockchain technology that has emerged in recent years.
DeFi aims to create small traditional financial pieces with an added layer of transparency and decentralization. These small pieces, like Lego pieces, can be put together to form an entire ecosystem of small solutions that when combined, create a fantastic financial solution that eliminates the need for opaque and centralized financial institutions that no longer add value.
DeFi, which stands for decentralized finance, is an umbrella term for a variety of blockchain-oriented public space applications and projects that are poised to wreak havoc on the world of traditional finance. DeFi refers to peer-to-peer applications and protocols built on decentralized blockchain networks and does not require access rights to facilitate lending, insurance, oracles, cryptocurrencies, swaps, derivatives, asset management, or financial tool trading. The Ethereum network is used to build the majority of DeFi applications today, but many alternative public networks are emerging that provide speed, scalability, security, and lower costs.
That is the idea that has driven the creation of the term “DeFi”, and the one that has led its evolution to the current point. In fact, it is currently impossible to ignore the huge impact that DeFi has on the crypto world. For that reason, we open a space to learn what DeFi is and how this idea is changing the global financial world.
That is the idea that has driven the creation of the term “DeFi”, and the one that has led its evolution to the current point. In fact, it is currently impossible to ignore the huge impact that DeFi has on the crypto world.
DeFi, The Concept That Is Transforming The Financial World
Consider a world in which anyone could create transparent, fair, and efficient financial products, causing banks, large finance companies, lenders, and insurance companies to fade into obscurity, or, better yet, to become completely unnecessary and disappear. But it is also a world in which anyone can freely interact with these products.
Well, this is what DeFi is. That is, it wishes to transform the current centralized finance structures into decentralized structures, without the use of trusted third parties, and executed on smart contracts or intelligent contracts within a blockchain where a written and unalterable record of each action performed is transparently reflected.
The impact of a trend like this is gigantic. We are barely in its early years and already the creativity of the world community is shaping alternative versions of almost all existing financial products.
Imagine that you need to obtain a loan to undertake. Instead of going to a bank, you can go to a DeFi platform and apply for a loan. Said loan has conditions (saving the technicalities) that are quite clear and transparent. All this is thanks to the fact that said loan will be controlled by a public and immutable smart contract.
Not only that, all the actions carried out on the platforms are visible and immutably recorded on the blockchain as well. Perhaps you do not have the knowledge to verify the reliability of the DeFi service, but due to its transparency feature, thousands of eyes will be able to analyze and question it, warning of its malfunction if so. And in the future, given the impact of this technology, children will surely be taught to read transparent smart contracts in school.
Thanks to DeFi, you will not need to be banked, you will not need to carry dozens of papers, queue to deliver them and wait weeks for a response. Instead, from the comfort of your sofa, with your smartphone, you can do the whole process of receiving the money in your possession.
However, DeFi can be much more, it can be the vehicle for the economy and finances of this increasingly present world that, with the help of Blockchain technology, begins to decentralize. The vehicle that opens the doors to international investments without so much bureaucracy, costs and time and with higher levels of trust and transparency. A vehicle for unbanked people to access services without the dictatorships of the banks, having the same conditions to personally evolve in their development.
Now that we know the concept, its origins and the differences between digital financial models, let’s know what the characteristics of DeFi are.
1. They work based on blockchain technology and smart contracts.
2. They are very safe. This is thanks to the fact that they use powerful cryptographic techniques to ensure that the platform, access and use thereof can only be carried out by authorized persons.
3. They have high levels of decentralization. The greatest potential of DeFi is its high level of decentralization. In other words, they can act without having to rely on a bureaucratic chain to control the platform’s functions.
4. No trust in third parties. This means that a platform’s action is direct between the user and the platform. Trusted third parties aren’t required because the blockchain will take care of everything. This structure will keep track of everything in a secure and immutable manner.
5. Transparent. Another great feature of DeFi is its transparency. Being built on free software, each line of platform code is auditable. In addition, the mobilization of resources is auditable, because they all take place on the blockchain.
6. Without Borders. A DeFi platform has no restrictions on who can use it. You can use its services from any country in the world with no problems.
DEFI PROTOCOLS AND HOW THEY WORK
DeFi has grown into a comprehensive ecosystem of applications and protocols that benefit millions of people. DeFi ecosystems currently hold more than $30 billion in assets, making it one of the fastest-growing segments of the public blockchain space.
The most popular DeFi use cases and protocols available on the market today is:
- DeFi lending and borrowing
DeFi gave finance a new direction by allowing decentralized lending and borrowing, billed as ‘Open Finance’, to offer cryptocurrency holders lending opportunities for annual returns. Decentralized lending allows people to borrow money at a specific interest rate, meeting the needs of the cryptocurrency holder community.
Best DeFi Borrowing and Lending Platform: Compound Funding
Rober Leshner came up with the idea for Compound Finance, which he launched in 2018. The project is an Ethereum-based lending protocol that enables users to earn interest by lending assets or borrowing against collateral. This is made possible by the compound protocol, which creates liquidity for cryptocurrencies by using interest rates determined by computer algorithms. When depositing cryptocurrencies, compound users earn interest. Users can use cryptocurrencies as collateral for loans once they are available on the Compound platform.
BENEFITS OF DECENTRALIZED FINANCE
- Overall System. Users can use decentralized finance to invest, transact and borrow money from people all over the world.
Blockchain technology provides decentralized finance with transparency.
- Without Intermediaries. The need for intermediaries to initiate transactions is no longer required. A transfer, for example, is made directly from the sender to the receiver, bypassing the sending and receiving banks.
- They Facilitate The Diversification Of The Investment Portfolio. DeFi makes it easier to invest in new financial assets such as cryptocurrencies. Investing in these financial assets, however, should be done with caution due to their high volatility.
- Full Control Of Assets. Users have complete control over their investments, but they must make sure that they are deposited on platforms that guarantee the assets’ liquidity.
- Blockchain technology guarantees that operations are carried out in a secure medium thanks to powerful encryption. When making a transfer using blockchain technology, it is received instantly.
- Cost Savings. By eliminating the intermediation of the banking sector, costs are reduced.
PROS AND CONS OF TECHNOLOGY
Of course, like all technology, it has its pros and cons, and for that reason, we will examine some of them.
1. Enables access to financial services to millions of people who are not banked. This is unquestionably a once-in-a-lifetime opportunity to provide development and financial freedom to those who, for various reasons, have been unable to benefit from these services.
2. It makes the international financing of companies and projects much easier. DeFi platforms can be tailored to the needs of a target audience in order to bring development and investments where they are needed. And such investments can safely come from anywhere in the world.
3. It creates a new point of economic diversification and development. In fact, due to the enormous economic potential of cryptocurrencies like Bitcoin, DeFi could be a significant point of economic development in the medium term.
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1. Security is still a point to polish within DeFi platforms. Although the blockchain has proven to be a very secure technology, there are still many things to improve, especially with the security and security auditing of smart contracts. A failure in a smart contract means a failure in the platform, as The DAO has shown.
2. Action protocols in the face of the volatility of cryptocurrencies. Many DeFi platforms have created operating mechanisms that guarantee their economic stability against the volatility of cryptocurrencies. However, many times these mechanisms seem insufficient. Or they simply do not fully protect the ecosystem against strong fluctuations. A situation that leads to millionaire losses. A case of this type is MakerDAO and DAI, whose fluctuations and correction actions have shown that decentralization and poorly adjusted action protocols can often be a weakness for these platforms if they are not handled correctly.
DEFI USE CASES
First of all, DeFi acts as a financial link between cryptocurrency owners’ wealth and the world of financial services that can be provided with that wealth in order to generate even more wealth.
That said, among the potential use cases of DeFi we can mention:
- Decentralized Lending Systems: this is, in fact, one of the primary applications of DeFi today. The system is straightforward: if a person needs a loan and wishes to use their cryptocurrencies as collateral or as a guarantee, they can do so without difficulty. The system operates in a manner similar to that of FinTechs or traditional finance. However, DeFi usually has better interest rates, and loans are approved almost instantly. Gone are the hours spent at the bank, sending digital documents and waiting days for a response; with DeFi, it is enough to interact with the DApp, make the required guarantee deposit, and you will have the money you requested as a loan in your possession, all in a matter of minutes.
- Decentralized Markets: Decentralized markets are another DeFi use case. DeFi enables the creation of decentralized exchanges (DEX), investment pools, financial derivatives, staking systems, prediction markets, and other innovations.
- Payment Systems: Another application for DeFi is payment systems. These platforms’ characteristics enable them to serve as a trusted bridge for processing payments from various blockchains via an external, decentralized, and autonomous infrastructure.
- Banking And Insurance Services: Another application of DeFi is to provide “banking” services without being a bank. There are DeFi protocols, for example, that allow their users to make a specific investment. However, after a while, you will be able to receive said investment with a profit margin, thanks to the interest that it has generated. Not only that but there are systems in place that allow for the creation of stable currencies (stablecoins), as well as digital identification and financial insurance systems.
THE FUTURE OF DEFI
Through the advancement of distributed ledger technologies, we are witnessing a quantum leap in new money functionalities. For the first time in history, a global financial system for a global population is being shaped by that same population. Everyone can get a seat at the table where the world of decentralized finance is actively being created by participating in the governance of DeFi protocols.
The DeFi space is gradually closing in on the traditional financial system, and despite some of the hurdles that are true while operating at the forefront of innovation, the world of decentralized finance is on the path to prosperity. Therefore, it is foreseeable that Defi will continue to expand in the coming year thanks to its many advantages. Companies and individuals must remain attentive to the financial innovations that are emerging thanks to decentralized finance and blockchain technology.