DeFi, or Decentralized Finance, is a concept that assumes that any currently available financial service, such as savings, loans, trading, cryptocurrency exchanges or insurance can be transferred to blockchain. And all this can be done without the involvement of banks and other intermediaries.
This has become possible using blockchains that offer smart contracts, or programs that run automatically when certain conditions are met. One of the most popular blockchains of this type is Ethereum, in operation since 2015, on which hundreds of decentralized applications (decentralized applications – daaps) offering smart contract services have now been created.
People’s imaginations heated up when it became apparent that two complete strangers from different parts of the world could negotiate a loan without the involvement of a bank, and in a way that was fully secured by the blockchain.
DeFi offers several advantages over traditional finance:
- It does not require the involvement of intermediaries like banks. Smart contracts can be agreed and executed directly between users
- The source code of many blockchains offering smart contract services is public and available to anyone, which also means transparency of transactions made on such a blockchain
- Decentralized applications have a global reach and it doesn’t matter whether someone lives in Europe or the Ivory Coast
- Freedom in creating decentralized applications, anyone can create them on their own terms
DeFi is a promising trend but it also has its drawbacks:
- Cryptocurrencies and the technology associated with them are not legal in every country
- The cryptocurrency industry is often not regulated by any official institutions, which can be both an advantage when you want to make transactions without intermediaries, but also a disadvantage, because there is no one to turn to for help in case of problems with recovering funds
- Defi projects are dependent on the price of the token
- The cryptocurrency industry is prone to hacking and fraud
- Considerable risk of losing funds associated with yield farming
- Possibility of errors and loopholes
DeFi fires up some people because of the possibility of quick profits, which is also why it has become so popular. Keep in mind, however, that quick profits can turn into big losses even faster, whether due to mistakes in the system of its infancy or to the premeditated actions of: hackers, scammers or creators of financial pyramids.
Benefits and applications of decentralized finance
If you’re up to date with the global blockchain scene, you’ve probably already heard of decentralized finance (DeFi, short for decentralized finance). It’s a collective term for the entire ecosystem of trends, theories and solutions currently emerging in crypto, fintech and other markets.
Wondering what decentralized finance is and why so many companies are interested in it?
Read our article to learn everything you need to know about DeFi, its advantages and how it can be used in everyday life.
Why is decentralized finance a breakthrough?
DeFi is an opportunity to transform the financial services sector by eliminating the need for time-consuming and costly intermediaries. This is made possible through the use of blockchain technology.
The rise in popularity of DeFi could lead to a reduction in the price and delivery time of financial services for both private and business customers. Blockchain also offers better protection against cybersecurity threats, which are becoming increasingly prevalent in the sector.
Until now, the cryptocurrency community has been the primary audience for blockchain technology. Decentralized finance is changing this situation, attracting the attention of politicians and traditional financial institutions. Nevertheless, we must keep in mind that the development of DeFi is dependent on technical, operational and regulatory challenges that may hinder it.
In order for DeFi to develop further, integration between traditional financial services companies and major political players, regulators and innovative technology start-ups must be improved. All the aforementioned organizations and individuals should work together to define the rules of the new ecosystem and support its rapid development.
No need for intermediaries
Traditional financial companies rely on numerous institutions that act as intermediaries. Using decentralized finance, you no longer need arbitrators or intermediaries.
Why? The application code determines how any problems and conflicts are resolved, and it is up to users to what extent they have control over their resources.
The result is lower prices for financial services and a more secure and conflict-free financial ecosystem.
No single vulnerability
At DeFi, services and products are deployed on a blockchain network. All data entered into the blockchain is located in thousands of nodes. This method significantly reduces the risk of potential total system failure, unwanted control or censorship.
The use of the blockchain network provides DeFi with a very high level of security. The system is not based on centralized servers that could fall victim to a single attack. On the other hand, however, when one user encounters a problem, there is no one to freeze or undo a transaction, as in traditional banks.
The decentralized financial ecosystem consists of blockchain-based applications that are interoperable. This could potentially accelerate the pace of its development and provide customers with a wider range of product choices that complement each other seamlessly.
Better access to financial services
Another advantage of DeFi is that they provide access to different services to more consumers. For example, traditional financial services companies rely heavily on intermediaries who also need to earn revenue from their profits, so it may be that low-income businesses cannot afford such services. Because decentralized finance enables significant cost reductions, it potentially gives more organizations and individuals access to financial products.
Challenges facing decentralized finance
DeFi applications rely on smart contracts and underlying blockchain protocols. A code error can potentially lead to huge losses. Since it is impossible to create error-free code, developers employ a variety of mechanisms that can help improve code quality. Even so, technical problems are a major threat to DeFi’s services.
Another challenge related to the technical implementation of DeFi is the user experience. It happens that applications and protocols are often complex, unintuitive and essentially designed for those in the cryptocurrency world. Even the best products may not be user-friendly for those who are not yet familiar with blockchain.
In most jurisdictions, DeFi projects operate without a license. Decision-makers are still working on rules for handling DeFi revenues, tax issues and other key aspects. As DeFi develops, new regulations will be needed to resolve ambiguities.
We hope this article has helped you understand how decentralized finance can change the face of the financial services sector. All of the listed examples of DeFi’s application would not have been possible if it were not for the continued development of blockchain.
If you know of other notable examples of DeFi usage, be sure to share them in the comments. There are so many new projects being developed in this area that it is difficult to keep up to date with all of them.
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