The finance industry is undergoing a fundamental change, and blockchain is guiding most of it. Cryptocurrencies and DeFi technologies are creating a new set of financial products and services, reducing the dependency on industry gatekeepers and central authorities.
In this article, we will briefly review how DeFi is changing the financial world for the better.
What is Decentralized Finance (DeFi)?
Decentralized Finance refers to a new financial system made with automated decentralized applications (DApps). Smart contracts are used to build DApps on the blockchain, and no single entity can control them. DeFi allows consumers to gain access to many financial products and services without the need for any central authority.
Blockchains and smart contracts allow users to manage the DApps directly. Many blockchains provide the infrastructure required for the development of DeFi apps. Ethereum introduced smart contracts, which led to the growth of the DeFi ecosystem.
DeFi today is a growing system of real-world protocols and applications. Banks generally provide services like giving interests, allowing users to borrow or lend money, buying insurance, exchange assets, and more. The new DeFi ecosystem lets you do all this and much more. It is also more secure than conventional banks. It may prove to be the future of the financial industry.
Characteristics of DeFi
Decentralized and permission-less
The DeFi protocols are built on permissionless blockchains. It has its currency and ecosystem. It means that users do not have to obtain permission from a central authority (e.g., government agency) to use them. They also do not have to share their identity to access these applications. These features combined make DeFi apps more accessible.
Non-custodial
Most of the Defi applications are non-custodial. It means that they do not hold on to the funds like a bank generally does. In centralized systems (such as banks), users have to lock funds with the entity. In DeFi, users can access various financial services without locking funds with any third party. They can access and remove these funds at will anytime. This ability gives a higher control over investment decisions in real-time.
Immutable
Fundamentally, blockchains are immutable. It means that no one can change the existing blocks. Since DeFi protocols use blockchain technology, they are tamperproof. It makes it practically impossible to change, reverse, or falsify records published on the chain. This immutability helps make DeFi systems more secure, private, and transparent. It is vital for the long-term safety and viability of the industry.
Open and interoperable
Network interoperability is the ability of various blockchain protocols to work, interact, and transfer value through cross-chain communication. Most public DeFi protocols operate using an open framework. It means they are accessible by anyone who can use the internet. DeFi applications have the potential to become available on different blockchains as they become interoperable.
Conclusion — Is DeFi the future of finance?
DeFi is still a new and unexplored region. Also, most of us are more familiar with the old and conventional finance. But traditional finance can be inconvenient. It is highly regulated, with multiple third parties involved. On top of that, a user has to pay numerous fees at different stages.
The DeFi movement is now stirring financial services to an open and decentralized world. It removes the need for intermediaries, which reduces the overall cost. It also substantially improves the security of the invested funds.
To summarize, DeFi offers many benefits to its users:
- It gives a higher level of autonomy within every transaction. Users do not require permission to conduct transactions or deal with waiting periods in DeFi applications.
- It provides better transparency in the transactions and any fee that has to be paid by the user.
- There is greater trust in the underlying blockchain technology compared to other intermediaries like banking institutions.
However, DeFi technology also comes with potential risks. Its biggest demerit is that it is less private than traditional finance. The transactions on DeFi applications are visible on the public blockchain.
Another drawback of the technology is the shared responsibility factor. The DeFi applications do not take responsibility for any mistake made by the user. Since there are no intermediaries, the users have to take responsibility for their funds and assets.
For now, it needs to be understood that DeFi is still a new technology that is being worked upon constantly. It will require much change before it can replace the traditional financial institutions.
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