Blockchain technology is revolutionizing the financial sector by facilitating the growth of DeFi or decentralized finance.
- Find out what DeFi or decentralized finance is.
- We explain the main advantages of decentralized finance.
The days of the financial sector, as we have known it up to now, are numbered, as more and more players are threatening the hegemony of traditional banks.
- What is the blockchain technology behind decentralized finance?
- What is decentralized finance?
- Benefits of decentralized finance
Banking is no stranger to these new trends, financial innovations, and changes in the environment, so it is in a permanent restructuring. Bank mergers, office closures and staff downsizing are something that most banking institutions have been signing up to for a few years now.
Technological giants, fintech and decentralized finance are players that are bursting into the banking market to transform it profoundly.
What is the blockchain technology behind decentralized finance?
DeFi are underpinned by blockchain technology, mainly Ethereum. Although more and more alternative and public networks are emerging that offer greater stability and security with lower costs.
Blockchain is a database of which all users keep a copy. That is, it is an immutable ledger of records, where the complete history of all transactions that have been executed is collected.
The blockchain is also the technology behind cryptocurrencies and acts as a large ledger that protects the security and privacy of transactions and allows eliminating intermediaries.
What is decentralized finance?
Decentralized finance or DeFi (Decentralized Finance) consists of a set of applications and online financial platforms that seek to create a more transparent and secure financial system that allows value to be exchanged without intermediaries.
Each decentralized finance project is different and offers certain characteristics, risks and opportunities.
This type of finance is based on blockchain technology. Thus, decentralized applications are used that are developed on public blockchain networks such as Ethereum.
DeFi operate through applications known as DApps (decentralized applications) that perform financial functions in financial records (ledgers) called blockchains (blockchains). This technology was first used by Bitcoin and has since spread widely.
Use cases would include financial contracts, mainly lending and investment, currency exchange, such as cryptocurrencies or interest earning.
DeFi platforms allow individuals to:
- Directly lend or borrow funds from third parties without the intermediation of banking.
- Speculate on the price movement of a range of assets using derivatives.
- Trade cryptocurrencies.
- Insure against risk.
- Earn interest on savings accounts.
According to the World Economic Forum, “decentralized finance aims to transform traditional forms of finance by rebuilding and reinventing services.”
In the latest 2021 report from the World Economic Forum (IMF), it is stated that, in the last year, the value of digital assets with DeFi contracts increased from $670 million to $13 billion.
Benefits of decentralized finance
- Global system. Users can use decentralized finance to transact, invest or borrow with users around the world.
- Blockchain technology endows decentralized finance with transparency.
- No intermediaries. The need for intermediaries to carry out transactions is eliminated. For example, a transfer is made directly from the sender to the receiver, without the need to go through the issuing bank and the receiver.
- They facilitate diversification of the investment portfolio. DeFi facilitate investment in new financial assets such as cryptocurrencies. Although investment in these financial assets should be made with caution due to their high volatility.
- Full control of assets. Users have full control of their investments, although it must be ensured that the assets are deposited on platforms that guarantee the liquidity of the investments.
- Blockchain technology ensures that transactions are carried out on a secure medium thanks to strong encryption.
- When a transfer is made using blockchain technology, it is received instantly.
- Cost savings. By eliminating the intermediation of the banking sector, costs are reduced.
Despite its many advantages, it also has some disadvantages, since users must have a minimum knowledge of how this technology works, especially in terms of network access and digital identity.
In addition, there is also a need for greater regulation by the monetary authorities. For this reason, the IMF has produced a guide to assist authorities in the creation of regulatory policies related to DeFi.
Therefore, it is foreseeable that DeFi will continue to expand in the coming years thanks to its many advantages. Companies and individuals should remain attentive to the financial innovations that are emerging thanks to decentralized finance and blockchain technology.
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