We know that the world is changing – and so are the rules of finance and the way financial transactions are conducted. Cryptocurrencies and blockchain technology have certainly had a major impact on finance and the way we buy, sell and invest. But it’s not just cryptocurrencies and blockchain technology that are changing the rules of finance.
Many companies have embraced a new world of finance called decentralized finance. This growing trend consists of blockchain-powered technologies that allow people to invest and transact more freely than ever before.
What is decentralized finance (DeFi)?
Decentralized finance, or DeFi, is an umbrella term for an ecosystem of financial applications based on blockchain technology. In technical terms, it is a modern initiative to develop a transparent, access-free and open financial services system that is easily and quickly accessible to everyone.
The most important aspect of a DeFi system is that there is no central authority, and no single person or group of people has much influence over the ecosystem. Instead, users of the system have complete control over their assets and manage the network democratically through decentralized apps (dApps) and peer-to-peer (P2P) technology.
One of the main advantages of DeFi is that it provides convenient access to financial services, especially for those who do not currently have the privilege of using the traditional financial system. In addition, DeFi is built on a modular framework, which means that all applications are interoperable.
Key features of the DeFi ecosystem
- Built on decentralized technology such as blockchain, with data stored across thousands of nodes.
- Terms of interaction between users are set by decentralized applications and smart contracts.
- Potential disputes are resolved through code, and until then, users retain complete control over their money.
- There is no involvement of any central authority, influential person or group.
- Services are easily accessible to anyone, anywhere, at a lower price than traditional banking.
The main advantages of decentralized finance (DeFi).
When we talk about decentralized finance, many may wonder why we need it at all. Traditional financial systems have worked well for decades, so is there really a need for a new ecosystem? Well, the answer is yes. First of all, we have gotten to this point through continuous and ongoing innovation. Stagnation in a market leads to degradation of services over time, and this is exactly why many traditional financial institutions, including banks, are now participating in the DeFi movement. Here are some other important benefits of DeFi.
Decentralization of the financial market
The current financing model provides a third party between the lender and the borrower, which is usually a bank. This third party holds all the cards and can deny services to anyone and dictate the terms and rules of the financial ecosystem. DeFi eliminates the need for a central authority, intermediary or regulator like a bank, and lenders and borrowers can interact with each other. This means there is no third-party influence or board of directors making important decisions for users.
Automated dispute resolution
The question arises: if there is no moderator between the interacting parties, who will resolve the disputes that will inevitably arise? The answer is quite simple – DeFi apps. They do not rely on arbitrators and are quite capable of resolving potential disputes according to the code. In the process of resolution, the user retains complete control over their assets.
More affordable financial services
It’s not exactly a secret that intermediaries like banks and financial institutions offer their services for a fee. They also use the deposited funds to make investments on behalf of users to make a profit. With decentralized finance, intermediaries become obsolete and financial services become much more affordable. You don’t have to pay service fees, commissions, and other hidden costs. DeFi is not completely free, but it is much cheaper compared to traditional banking.
Not a single point of failure
It is common for your banking and financial services to fail because the systems are not infallible. Usually, there is a single point of failure, which means that a single glitch can bring down the entire system and disrupt access to financial services. Decentralized finance, on the other hand, relies on blockchain technology, where there are no single points of failure. Data is stored on the blockchain, which is distributed across hundreds or even thousands of nodes. This means that any possible suspension or censorship of services is extremely unlikely.
Access to financial services for the unbanked and underbanked.
Although we have come a long way in the twenty-first century in providing people with access to basic financial services, there are still millions of unbanked and underbanked people, especially in underdeveloped countries. This means they do not have access to the full range of financial services they need to be optimally productive and efficient in their lives. DeFi provides these people with easy and fast access to financial services because it is an open-source ecosystem where profit-making is not the primary goal. Since it is more affordable, it will also encourage the adoption of DeFi services in low-income communities.
Quick and easy system implementation
When traditional financial systems need to be upgraded or updated, they have to stop their services for a few hours. This is not the case with decentralized financial systems. The system can be updated on the blockchain in real time and can be developed in advance. This makes the implementation much less complicated and very secure.
How does DeFi work?
DeFi can be considered a parallel financial system that is not managed by central institutions like banks. It is an emerging ecosystem for managing financial assets on the blockchain. The goal of DeFi platforms is to provide alternatives to traditional banking that allow individuals to take control of their finances.
In a decentralized system, money can be converted into what is known as a stablecoin. This is a digital replication of the euro, the U.S. dollar, or other fiat currencies. Since the value of the euro does not change that quickly, stablecoins provide stability in the cryptocurrency market. These stablecoins can then be lent out and interest can be earned on them.
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