Decentralized finance: What to know about decentralized finance?

By Flinston
12 Min Read
Decentralized finance

Decentralized finance: Various sorts of intermediation are used in cryptocurrency markets. While certain kinds of crypto intermediation have clear analogies in conventional banking, others – referred to as decentralized finance – are essentially novel and have just lately acquired prominence. Decentralized finance is the provision of financial services without the need of centralized middlemen, using automated protocols on blockchains.

Decentralized finance is fast gaining popularity as a more secure, transparent, and efficient alternative to conventional financial services. We are establishing a more open, reliable, and accessible financial system by removing the need for centralized financial institutions.

Decentralized finance, which is protected by blockchain technology, reduces the danger of fraud, corruption, and mismanagement of your assets. It will also make financial management much more cost-effective and efficient, since there will be no overdraft fees, no wire transfer costs, and no waiting during banking hours for a transaction to be processed.

What is decentralized finance?

Decentralized finance, or “DeFi,” is a developing digital financial infrastructure that ideally removes the need for financial transactions to be approved by a central bank or government agency. Many consider DeFi to be an umbrella name for a new wave of innovation, and it is inextricably linked to blockchain. Blockchain technology enables all computers (or nodes) in a network to maintain a copy of transaction history. The goal is that no entity has control over or has the ability to edit this transaction registry.

The Ethereum network hosts the majority of the financial services that may be classified as DeFi. This network is home to the world’s second biggest bitcoin market. It also serves as a platform for the development of additional blockchain applications.

Two or more parties may trade, lend, borrow, and trade directly utilising blockchain technology and smart contracts using decentralized apps, or dApps, without the participation and fees of middlemen. In principle, it’s a fair, free, and open digital marketplace.

How to understand decentralized finance?

Decentralized finance, or DeFi for short, refers to a financial system that does not rely on conventional, centralized middlemen. We’re used to everything passing via a bank or other financial institutions, such as a worldwide exchange, but DeFi establishes a system that can function independently.

To comprehend decentralized finance and how it works, it is necessary to first understand how it differs from centralized finance.

Centralized finance

Your money is kept by organizations whose main goal is to earn money in centralized finance. Third parties that enable the transfer of money between parties abound throughout the financial system, each demanding a charge for their services.

Assume you use your credit card to purchase a gallon of milk. The merchant charges the fee to an acquiring bank, which forwards the card information to the credit card network.

The charge is cleared by the network, and payment is requested from your bank. Your bank authorises the debit and sends it back to the network, through the acquiring bank, to the merchant. Each business in the chain is compensated for its services, which is mainly due to retailers having to pay for your ability to use credit and debit cards.

All other financial activities are costly; loan applications might take days to be accepted; and you may not be able to utilise a bank’s services if you are travelling. Things are changing, though, thanks to decentralized money. Let’s see…

Decentralized Finance

By enabling consumers, merchants, and enterprises to execute financial transactions using developing technologies, decentralized finance reduces the need for intermediaries. This is done using peer-to-peer financial networks that use enhanced security protocols, connection, software, and hardware.

You may lend, trade, and borrow using software that records and validates financial equities in distributed financial databases from wherever you have an Internet connection. A distributed database is accessible from several locations; it gathers and aggregates data from all users and verifies it using a consensus process.

Decentralized finance makes use of this technology to abolish centralized finance models by enabling anybody, regardless of who or where they are, to utilise financial services everywhere.

Through personal wallets and trading services tailored to people, DeFi applications provide users greater control over their money.

Finally, decentralized finance may be considered to hasten financial inclusion.

How does decentralized finance work?

DeFi, rather than a bank, employs technology to facilitate transactions and services between parties. A financial system, on the other hand, is made up of two major components: an infrastructure and a currency.

Banks and financial organizations serve as this infrastructure in a centralized system. Fiat currency, on the other hand, such as the US dollar, functions as money.

To provide a comprehensive range of financial services, decentralized finance must replace these components.

Infrastructure

Ethereum is a platform for developing decentralized applications. We can develop smart contracts thanks to Ethereum. You may use these contracts to create a set of rules for how a financial service runs and then deploy those rules on Ethereum. A smart contract cannot be altered after it has been deployed.

On Ethereum, users may create decentralized apps to provide any financial service and let smart contracts to operate these services autonomously.

The currency

A stable currency is required to build a dependable and secure decentralized financial system. Bitcoin does not work with the Ethereum platform, while Ether, Ethereum’s own programmable coinage, is very volatile. As a result, a currency or stable currency, the “stablecoin,” is required.

A stablecoin is a cryptocurrency whose value is matched by fiat cash. DAI is a decentralized stablecoin that is backed by the US dollar. This indicates that 1 DAI is equivalent to 1 USD. The value of DAI is secured by cryptocurrency collateral rather than directly by US dollar reserves. The DAI is the best money for decentralized finance because to its stability.

Read more: Peer to Peer (P2P): What are Peer to Peer payments?

Decentralized financial services

The advantages of a decentralized financial system extend beyond online and peer-to-peer payments. Money transmission is merely one part of the centralized financial system that has always existed. Decentralized finance aims to replace all parts of finance, such as exchanges, loans, insurance, and savings programs.

Ethereum smart contracts enable these decentralized services to exist and run in a fair and safe way.

The following are some of the financial services that Ethereum already supports:

Decentralized borrowing and lending

Lending and borrowing money centers on the people engaged in centralized finance. Before lending, banks need to determine whether you are likely to repay a loan. Decentralized lending, on the other hand, operates without either side needing to identify themselves. Instead, the borrower must offer collateral, which the lender will obtain if the loan is not repaid. NFTs are even accepted as security by certain lenders.

You may acquire a loan in minutes thanks to decentralized finance. This is without the need to go through a difficult or time-consuming application procedure.

The compound is an Ethereum-based application that allows for decentralized peer-to-peer lending and borrowing. Compound links lenders and borrowers automatically and administers loans autonomously via smart contracts.

Since a result, so-called “yield farming” has grown in popularity, as anybody may lend out their crypto assets and earn income in the process.

A compound may also be used to deposit bitcoin as collateral and borrow fiat money against it.

Decentralized exchanges

On the Ethereum network, we may use the Decentralized Exchange (DEX) to buy, sell, and exchange cryptocurrencies. This is done without the use of an exchange operator, without the requirement for registration or identification verification, and with no withdrawal costs. Furthermore, unlike centralized exchanges, trading using DEX does not need any upfront investment.

Transactions are completed autonomously, with smart contracts guiding the circumstances and procedure.

Decentralized insurance

Decentralized peer-to-peer insurance is also conceivable thanks to smart contracts in the decentralized financial system. You may connect with anybody in the globe who wishes to guarantee your assets in a decentralized financial system.

On the other hand, you may insure the assets of others for a fee without ever having to deal with an insurance firm or agent. Everything occurs on its own, with smart contracts providing a fair, safe, and trustworthy procedure.

What future of decentralized finance?

Through the advancement of distributed ledger technology, we are seeing a quantum jump in the new possibilities for money functioning. For the first time in history, the same people are shaping a global financial system for a global population. Anyone may take part in the governance of DeFi protocols and sit at the table where the world of decentralized finance is being actively built.

The DeFi industry is catching up to the conventional banking system. Despite certain setbacks, the world of decentralized finance is on the rise. It is difficult to forecast how this field will evolve over time as the ability to develop financial services becomes more democratized.

However, as DeFI and fintech map out and integrate, we will reach a tipping point in which fledgling fintech will be simply a component of a new financial system. The person who makes the goal of being quick, safe, accessible, and egalitarian a reality.