What is Decentralized Finance?
Decentralized Finance reached $1B in value last month and continues to grab attention from investors. But what is Decentralized Finance?
Compared to traditional finance, the key difference with DeFi (Decentralized Finance) is that it’s decentralized, aiming to bring financial tools and services to the blockchain network. What this means to the user is that at any time they are able to use these tools without being restricted by an entity, without needing KYC (Know Your Customer), and without requiring credit checks. This allows for more accessibility to people who were previously denied from the system.
Current Implementations
One of DeFi’s main implementations is with loans. Currently, most of DeFi runs on Ethereum’s smart contract network based on computer code. These smart contracts are programmed to handle loans, providing an alternative to current institutions such as banks. This allows the user to borrow through a permissionless system. However, at its current stage these loans require you to deposit a collateral that ends up being larger than the amount you are able to borrow.
On the other side of borrowing is lending. These implementations can often offer a much higher interest rate compared to traditional financial services. As of now, Dai (a stablecoin built by MakerDAO) offers a 7.5% Dai Savings Rate. This makes it great for savings, however with the higher interest rate comes with a higher risk from possible hacks and exploits that could occur in the code.
Another major implementation of DeFi is a DEX (Decentralized Exchange). Often times, many users are worried about the security of an exchange, whether it’s with doing KYC or with the cryptocurrencies that they hold on that exchange. Along with this, if a user is living in a region where the exchange is restricted, they would not be able to trade. However, with a DEX they can have an alternative to this. A DEX allows them to trade directly from their private wallet, instead of having to trust their cryptocurrencies with an exchange. Current DEX’s on the DeFi network include dYdX which offers margin trading, and Synthetix which offers more trading pairs for crypto and commodities, with plans for stocks.
Finally, another implementation of DeFi is with automated portfolio management. Instead of having to manually follow a trader, a user can now follow their portfolio strategy automatically. This allows them to follow a set investment strategy and remove emotional driven actions. This implementation is called TokenSets.
As blockchain technology continues to develop, and the DeFi network begins to grow, the possibility of having an open alternative to traditional banking would be a massive game changer.
