What is DeFi? Everything you need to know
The global financial crisis of 2008 is a fine example that highlights the inadequacies of the traditional financial system and thus the call for a better financial landscape. This becomes easy with the creation of Defi.
Defi is an ecosystem that enables the use of financial services such as: Lending, borrowing, accessing insurance and more. Without the need for third parties to be involved. No centralized authority like banks or governments is needed to censor. Defi revolutionizes conventional trading of financial services by eliminating the need for third party involvement. These financial services are offered through Decentralized Applications (Dapps), most of which are deployed on the Ethereum platform.
There will be advancement in the defi domain in the coming years and is a key component in fulfilling Ethereum’s lofty vision and ambition. Disempowering middlemen and gatekeepers (banks) and empowering ordinary people via peer-to-peer exchanges is a key challenge for centralized censor banks. Defi is about unbundling traditional finance. In Defi (decentralized finance), anyone in the world can send money to others for a small fee at any time and from any location, completely erasing middlemen. 2020 was the year Defi actually gained prominence and acceptance in the market.
The goal of Defi
The goal of Defi is to give its users full control over assets through decentralization and blockchain technology. Since it is an open source platform, developers can build more and more financial products with the help of collaboration with people around the world which leads to nimble innovation and secure network.
Anyone in the world can store, trade, and invest their assets securely on the blockchain from any location, earning a much higher return than the traditional financial system. Since there are no middlemen in handling your assets, you have full authority and control over your investments.
Today, people put their savings in an online savings account and get 0.5% interest on the money. Then traditional banks gamble with the money by, say, flipping it or lending it to other customers at 3% interest for a 2.5% profit. But not anymore, since Defi connects lenders directly to borrowers, erasing the need for banks. With Defi, people would lend their savings directly to others, eliminating a bank’s 2.5% profit loss and giving them the full 3% return on their money. There’s a chance people think we already do this when we send money using PayPal, CashApp, or Venmo. But we don’t. You still have a debit card or bank account linked to these apps to send money, so these P2P payments still rely on centralized financial middlemen to work.
Defi creates the opportunities and allows users to access different financial tools without restrictions on race, religion, age, nationality, location or geography.
How can businesses benefit from DeFi?
Defi provides an unprecedented example to the traditional financial and banking system. Defi is a fancy financial landscape using internet and blockchain technology. The three main segments that would benefit from the Defi network are the payment processing system (remittances), accessibility and transparency of centralization.
- Payment Clearance System: If you are trying to send money to someone in another country, you will surely face some problems. Banks usually take a few days to transfer money and charge all sorts of fees. There are also other issues such as documentation, compliance with money laundering laws and privacy concerns.
Example: If Alice wants to send $1000 from the US to Casper, who lives in Australia, there would be three fees: the bank’s exchange rate, international inbound fees, and international outbound fees. Last but not least, it would take a few days for the payment to be transferred to Casper’s bank account.
Now with the help of Cryptocurrencies all the intermediaries would be eradicated like banks. It is faster and the transfer of money would continue without question with relatively lower fees as compared to banks. Transferring Cryptocurrencies anywhere in the world would take 15 seconds to 5 minutes depending on several factors along with a small fee.
- Accessibility: More than 1.7 billion people in the world are unbanked and free to get financial services. But with the help of Defi and Dapps, these people would get the opportunity to get financial products. Basically, Defi is trying to provide cross-border, censorship-free and accessible financial products to all people. Defi shows no bias towards any particular race, gender, religion, age or nation and instead provides a playing field for all.
- Centralization transparency: There is no denying that conventional, regulated financial institutions that adhere to government laws and regulations, such as banks, are among the safest places to keep funds. But they are not without vulnerabilities. Even reputable banks can fail. Washington Mutual with over $188 billion in deposits and Lehman Brothers with $639 billion in assets both failed in 2008. Over 500 bank failures were recorded in the US alone.
Among the events that led to the 2008 financial crisis was that the rating agencies gave AAA high risk mortgage backed securities ratings (best and safest investments). The 2008 financial crisis introduced new ideas into the world. Defi is one of them. Defi protocols, developed on permissionless public blockchains like Ethereum, are usually open-sourced for control and transparency. They usually have decentralized governing organizations to ensure that everyone knows what is happening and that no vice actors can make bad decisions on their own.
Defi protocols are written as lines of code – you can’t modify, change or cheat the codes because they treat every participant equally without discrimination. The codes run exactly as they are programmed, and any errors quickly become obvious as they are publicly viewable. Defi’s greatest strength comes from its ability to suppress middlemen and operate with zero censorship.
What are the advantages of Dapps?
Dapps are built on decentralized blockchain networks like Ethereum and generally have the following advantages:
Immutability: no one can change information once it is on the blockchain.
Tamper-proof: smart contracts published on the blockchain cannot be tampered with without alerting all other participants on the blockchain.
Transparent: smart contracts running Dapps are openly auditable.
Availability: as long as the Ethereum network is active, the Dapps built on it will remain active and usable.
Platforms for Developing Defi Applications:
The DeFi market is tiny compared to traditional finance, but it has been rapidly picking up steam since last year. With more projects and financial dapps, we can expect to reach a truly decentralized financial reality.
Some of the things we can achieve with DeFi:
- Transparency: a transparent, verifiable financial ecosystem.
- Accessibility: free access to DeFi applications without fear of discrimination based on race, gender, creed, nationality, or geographic status.
- Efficiency: programmable money allows for the removal of centralized middlemen to create a cheaper and more efficient financial market.
- Convenience: money can now be sent anywhere, anytime, to anyone with access to a cryptocurrency wallet, for a small fee and with little waiting time.
- Wider Global Access to Financial Services: Defi make easy and possible for anyone who has an internet connection and a smartphone could access financial services. There are a lot of barriers that prevent access in the current system. Like status- Lack of citizenship, documentation and credentials. Wealth- High entry fees required to access financial services. Location- Great distance from functioning economies and financial service providers. In a decentralized financial ecosystem, a top trader at a financial firm would have the same access as a farmer in a remote region of Pakistan, India or Kenya.
- Affordable Cross-Border Payments: Decentralized finance eliminates costly intermediaries to make remittance services more affordable for the global population. In the current scenario, it is very expensive for people to send money across borders. The average global remittance fee is 7%. By opting for the Defi financial system, the remittance fees could be less than 3%.
- Improved privacy and security: in Defi, users have full control over their assets and can conduct secure transactions without confirmation from a central authority. Unlike the current system, custodial institutions put assets and information at risk if they do not secure them.
- Ease of use: plug-and-play apps will allow people to use defi services intuitively, without the complexity of the centralized system. A man in Kenya could get a loan from the US, invest in a business in Turkey, and then pay off his debts and buy a house – all through the interoperable apps.
Decentralized Finance focuses on developing financial services detached from the conventional financial and political system. This would allow for a more open financial system and could potentially prevent precedents of censorship and discrimination around the world.
As tempting as the idea is, not everything benefits from decentralization. Finding the use cases that are best suited to blockchain properties is critical to building a useful stack of open financial products.
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