What is Decentralized Finance (DeFi)?
Decentralized finance DeFi, is a rapidly expanding sector of the cryptocurrency business. While cryptocurrency coins provide a decentralized store of value distinct from any government-backed fiat currency, DeFi establishes decentralized financial instruments apart from conventional centralised institutions.
Although relatively tiny in comparison to the global economy, DeFi is expected to expand rapidly in 2022. In early 2019, the DeFi economy had just $275 million in crypto collateral but by February 2020, that figure had risen to $1 billion, and it has continued to rise steadily throughout the year, reaching $2.5 billion in early July, $3 billion by mid-July, and $4 billion on July 25.
This increase indicates that there is considerable interest in DeFi inside the crypto community, but it is still a tiny enough market that many people outside the space may not be aware of it. So, let’s have a look at what’s decentralized finance and why it’s so fascinating.
What’s the Hype About DeFi?
In the blockchain world, DeFi is already a hot subject. In contrast to the decentralisation of money achieved via Bitcoin, decentralized finance DeFi seeks to decentralise the conventional financial sector in general. The initiative’s primary goal is to make conventional financial services available to everyone by creating a permission-less financial service ecosystem built on blockchain technology.
DeFi is defined as “an ecosystem consisting of apps developed on top of public distributed ledgers to provide permission-less financial services.”
DeFi is a bold effort to decentralise key conventional financial use cases such as trading, lending, investing, wealth management, payment, and insurance on blockchain. DeFi is built on protocols or Decentralized Applications (dApps). By operating these dApps on a blockchain, a peer-to-peer financial network is created. Every dApp, like lego building bricks, may be joined with others. Smart contracts function as connectors, similar to precisely defined APIs in conventional systems.
How Did DeFi Get Started?
Initially, humans traded goods and services. However, economies have developed alongside us: humans created money to enable the exchange of commodities and services. As a result, currencies aided in the introduction of innovations and the development of higher economic levels. Progress, however, comes at a cost. Historically, policy makers have issued currencies that underlie our economy, giving them greater authority as more people came to trust them.
However, confidence has wobbled from time to time, prompting individuals to doubt centralised authorities’ capacity to handle such large sums of money, as well as its mandate and purpose. DeFi was created with the goal of establishing a financial system that is accessible to everyone and reduces the need to trust and depend on a central authority for governance.
DeFi offers a multitude of possibilities for creating a transparent and strong financial system that is not controlled by a single body. However, the turning point for financial apps started in 2017, with initiatives that enabled more functionality than just money transfers.
Financial markets have the potential to produce great ideas and promote social prosperity. However, power is concentrated in these marketplaces. People that invest in today’s financial system entrust their assets to intermediaries such as banks and financial institutions, which puts risk and control at the centre of these systems.
Historically, bankers and institutions have failed to recognise market threats, as shown by the 2008 financial crisis. Without a doubt, when central authorities manage the money, risk builds in the centre, endangering the whole system.
Bitcoin and other early cryptocurrencies, which were designed to offer people total ownership over their assets, were merely decentralized in terms of issuance and storage. Access to a wider range of financial instruments remained a problem until the advent of smart contracts, which supported decentralized finance DeFi.
DeFi is Based on Blockchain
Blockchain and cryptocurrency are the foundational technologies that allow for decentralized finance. When you complete a transaction in your traditional checking account, it is recorded in a private ledger—your banking transaction history—owned and maintained by a big financial organization. Blockchain is a distributed, decentralized public ledger that records financial transactions in computer code.
When I say blockchain is distributed, I mean that every party utilising a DeFi application has an identical copy of the public ledger, which records every transaction in encrypted code. This protects the system by giving users anonymity, as well as payment verification and a record of asset ownership that is almost impossible to change via fraudulent behaviour.
When I say blockchain is decentralized, I imply that there is no intermediary or gatekeeper in charge of the system. Transactions are validated and recorded by parties that utilise the same blockchain, who solve difficult math problems and add fresh blocks of transactions to the chain.
DeFi proponents claim that the decentralized blockchain makes financial transactions more safe and transparent than the private, opaque methods used in centralised finance.
What is the Potential of Decentralized Finance DeFi?
Why decentralized finance? DeFi has been designed for a wide range of applications. Let us look at three major advantages of decentralized finance DeFi.
Lending and Borrowing
Today, we leave our money or assets in the hands of banks. We get minimal interest while banks utilise our money to generate more money, for as by making loans and earning high interest. Rather than leaving your money with banks, you may lend it directly to DeFi using digital assets such as Bitcoin. This means you may get your full interest earnings without having to pay any processing or risk costs to banks.
Stablecoins in Reducing Cryptocurrency Volatility
It is well known that digital currencies such as Bitcoin fluctuate, making them difficult to use in everyday life, while stablecoin do not. A stablecoin is a cryptocurrency that is linked to an underlying asset, such as gold or FX reserves, and acts as collateral. Their values stay stable and devoid of dramatic fluctuations. USDT is an excellent example of a stablecoin since each token is worth one USD. Aside from reduced volatility, stablecoins enable users to construct virtual assets on DeFi. Any token may be used as collateral, which means you can digitally sell any real-world asset, like cash, gold, real estate, or stocks.
Raising Funds Digitally
Because there are so many physical assets in the world, it is almost impossible to have as many digital assets as there are physical ones. As a result, frameworks for tokenising financial assets like bonds or stocks were created. We can now raise money digitally/virtually under approved supervision, rather than going through time-consuming procedures like IPOs. With the passage of time, we may discover that individuals prefer digital methods over traditional methods.
Comparison Between Traditional Finance vs. Decentralized Finance DeFi
|Traditional Finance||Decentralized Finance DeFi|
|Companies hold your money||You keep your money in your possession|
|You must trust companies not to mismanage your funds, such as lending to unsuitable borrowers||You have complete control over where your money goes and how it is spent|
|Due to laborious procedures, payments may take days||Fund transfers take just a few minutes|
|Your financial behaviour is inextricably linked to your identity||Trades are pseudonymous|
|To utilise financial services, you must first apply||DeFi is available to everyone|
|Employees need breaks, so markets are shut||The markets are open 24 hours a day, seven days a week|
|Financial institutions have closed books: you can’t request their loan history or a list of their managed assets, for example||It’s based on openness, so anybody can have a look at the data and see how the system works|
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