The launch of Bitcoin in 2009 gave birth to robust blockchain technology. The cryptocurrency and blockchain space features several niches in which organisations and projects create solutions for different use cases.
DeFi, or the decentralised finance sector, is one such niche. With DeFi, you can carry out most of the things banks support — lend, borrow, earn interest, trade derivatives, buy insurance, trade assets, etc. But it is faster and does not need a third party or any paperwork.
It does sound interesting. Hence crypto enthusiasts must be aware of all the vital aspects. This article illustrates those aspects. Read through the end to gain insight.
Decentralised finance or DeFi is an umbrella term for different financial applications in blockchain or cryptocurrency geared towards disrupting financial intermediaries. It is based on secure distributed ledgers.
DeFi aims to create a permissionless, transparent and open-source financial service ecosystem which operates without any central authority and is available to everyone. Users will have total control over their assets and interact with this ecosystem via P2P (peer-to-peer) and DApps (decentralised applications).
Decentralised finance is primarily based on Ethereum and is all about code. It uses smart contracts and cryptos to offer services which do not require intermediaries.
Financial institutions play the role of guarantors of transactions in today’s financial world. A smart contract replaces these financial institutions in a transaction in decentralised finance.
A smart contract can hold funds and refund or send them depending on several conditions. When live, a smart contract always runs as programmed, and no one can alter it. The following illustration clarifies:
Suppose a contract that is engineered to offer an allowance can be programmed to send money from Account X to Account Y every Friday. For that matter, it will only do so as long as Account X contains the required funds. No one can change the contract and add Account Z as a recipient to steal funds.
Also, contracts are public for any individual to audit and inspect, implying bad contracts will quickly come under community scrutiny.
DeFi is an emerging system aiming to revolutionise the traditional finance segment. It boasts the ability to be a financial tool outside of regulatory and government control. This makes it potent enough to disrupt traditional finance. Given below is a comparison between DeFi and traditional finance:
|You must trust financial institutions regarding money management – they should not mismanage your money, including lending to risky borrowers, etc.||You get to manage your money – where it goes and how it is spent.|
|You need to apply to use financial services.||DeFi is open to any individual.|
|It can take several days for payments to complete because of manual procedures.||Fund transfer can take place in minutes.|
|Transaction activity is closely coupled with your identity.||Financial activity is pseudonymous.|
|Financial institutions hold your money||You get to hold your money|
|You cannot look into loan history, a record of managed assets, etc., with financial institutions.||Any individual can look into a product’s data and check how the system works.|
|Markets close down at certain times due to several reasons.||Markets are open at all times.|
Decentralised exchanges or DEXs refer to peer-to-peer marketplaces where crypto traders directly make transactions without the need for a trusted intermediary to hold the money. These directly connect users, and with the help of smart contracts, the trades directly take place between user wallets.
Usually, DeFi exchanges do not provide custodial wallets, and users connect to these platforms via a Web3 enabled application or browser extension like Binance Chain Wallet, Coinbase Wallet, MetaMask, etc.
After connecting to the platform with the wallet, you can begin exchanging cryptocurrencies via plain, easy-to-use user interfaces that a majority of the DeFi exchanges offer.
Decentralised marketplaces refer to trustless networks that are built on blockchain technology and enable investors to trade without the involvement of middlemen. They enable individuals to transact and interact on a global, self-executing, permission-less platform.
At its core, a decentralized marketplace matches sellers and buyers of services and goods. Instead of a person, a smart contract or program controls a majority of the vital functions like releasing funds and executing trades.
Listed below are some of the key DeFi use cases:
Given below are some of the risks of DeFi:
DeFi bears the potential to revolutionise the financial sector when concerns regarding privacy and data security are increasing. But first, it must address issues related to liquidity, regulations, scalability and security.
There was less than $20 billion worth of value that was locked in different DeFi products as of November 2020. A majority of these were on Ethereum. It was worth over $260 billion by the next year, with Binance Smart Chain alone contributing $19 billion. If this trend goes on and the decentralised finance maximalists are right, it can be just the start of a monstrous DeFi wave.
DeFi has gained significant momentum over the years. Crypto enthusiasts looking forward to them must keep in mind all the above-mentioned vital aspects. Also, they must ensure to carry out extensive research before interacting with DeFi applications due to the considerable risk involved.