DeFi, short for decentralized finance is an umbrella term for services like investing, borrowing, lending, and trading that work on a decentralised network of computers instead of a single server. DeFi is commonly referred to as a collection of financial applications built on blockchain. With things changing quickly in the crypto space, DeFi is an ongoing trend – making it an exciting place to be. In this article, we will explore more about what DeFi is and why is it such a craze in current times.
What is DeFi?
DeFi or decentralized finance is an umbrella term for the large variety of applications and projects built on public blockchain space with an aim to disrupt the traditional finance world. DeFi applications are built using smart contracts, on blockchain technologies. Smart contracts are contracts that enable transactions between two parties without the need for an intermediary. Smart contracts ensure that the transaction happens in a transparent manner.
The majority of DeFi applications are built on the Ethereum network, but many alternate public networks are emerging with a promise to deliver superior speed, scalability, security, and lower costs. DeFi applications and peer-to-peer protocols are built on blockchain networks that do not require access rights and in turn provide an easy borrowing, lending, or trading of financial tools.
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Problem with Centralized Finance
While investing in a traditional way, the control of the finances is passed over to an intermediary or a central authority. It leads to keeping both control and risk at the centre of the system endangering the entire system if any crisis arises. Additionally, investing money in banks leaves the money in the control of the banks instead of an individual. In terms of emergency, bank runs can quickly drop to zero leaving people devoid of their own money. This is why a centralized finance system poses several problems and needs are being challenged.
How does DeFi work?
DeFi works on a basic principle of avoiding the need for an intermediary while carrying out financial transactions. It uses smart contracts and cryptocurrency to provide financial services. Such services include getting an instant loan, earning higher interest rates as compared to banks, making peer-to-peer trades with a broker, and buying stock options and futures contracts.
DeFi is an open-source platform allowing users to innovate and inspect the applications. As a result, users can create their own DApps by mixing and matching different protocols to create unique combinations.
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Why do we need DeFi?
DeFi is important in today’s times to create an open financial market that is trustless and permissionless. Most of the upcoming fin-tech firms and new-age banks promise about giving control over to the consumers but in reality, this isn’t entirely true. In most cases, the control still lies with the bank and the customers have to trust the bank to take good care of their money. The new banks may be faster and more convenient but the basic principle behind their operation remains the same as traditional banks.
DeFi enables true disruption by transferring full control of the assets and the access to the individual. This is why many financial products are moving towards open-source protocols to let individuals make transactions through decentralised platforms. The new DeFi platforms have several advantages over the traditional ones:
- Permissionless:
With the lack of central control and access being passed on to every single individual, there are more possibilities to unlock many known and new forms of value. No more trusting an intermediary to take care of an individual’s assets.
- Globally accessible:
The second major advantage of DeFi comes from all its protocols being open source allowing anyone to build new financial products on top of them. This will lead to a much faster innovation as people from all over the world can come together and collaborate.
- Programmable:
DeFi is more secure and customizable as they are built using smart contracts. The transaction control lies with smart contracts instead of people resulting in limitless possibilities.
- Composable:
DeFi applications are composable which means there is no limit to what can be built. Everything can be put together in several combinations and there is no wrong fit.
- Interoperable:
The interoperable feature of DeFi applications means that the user is not restricted based on nationality, income, or the bank they use. There are several functions working in harmony irrespective of their creators. DeFi applications are completely transparent.
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The Future of DeFi
By taking out the middlemen the promise and potential of DeFi seem to be far-reaching, even though there is still a lot of work to do on it. With the onset of DeFi, investors will have a lot more freedom to deploy their assets in creative ways. With all its advantages, DeFi still has a long road ahead, especially when it comes to the general public entrusting its capabilities. DeFi comes with its own risks and downsides which going forth will be resolved to ensure a more robust ecosystem.
Conclusion
DeFi has revolutionized the finance industry. It opens up the world of finance and banking to the entire planet without any discrimination. With low barriers to entry and unlimited possibilities, DeFi applications have been game-changing. DeFi moment has become the most promising offering of the decentralised space. Not only does it have an intriguing tech behind it but also brings a unique opportunity to change the way we have been handling finances.
