What is DeFi? (decentralized finances)

What is DeFi? (decentralized finances)

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what is defi

Most, if not all, of the users, are supporters of decentralized solutions and are trying to move away from traditional financial solutions. In this article, we will discuss DeFi in detail, show the most important differences between centralized and dispersed solutions, and check what services the DeFi is best suited to.

Why does the world need a new solution?

Nowadays, almost all financial services are centralized, which means that there are entities behind the given institutions that have control over them. A good example in this case is the banks where money and savings are held by a very large group of people. This works well on a daily basis. But what can happen in a crisis situation?

It is the banks that have control over the money

Under normal circumstances, bank customers have no problems managing their money. However, in times of emergency, a bank may, for example, freeze funds in an account. Similarly, if a bank collapses or authorities fail to meet their obligations, the value of the money in the account may decrease or we may not have access to it.

To make it easier to imagine such a situation, we can look at Venezuela, which is plagued by hyperinflation caused by the government’s inept management of the state. Every day Bolivar, the country’s national currency, loses value. Citizens prefer to invest their money in more certain assets, such as cryptocurrencies.

Decentralized solutions seem to be a cure for such problems.

Another important disadvantage of relying solely on the banking system is that not everyone in the world has access to traditional banking and thus does not have access to some services such as taking loans and credits. DeFi is supposed to make these chances equal.

DeFi – how does it work?

DeFi is a term referring to the financial ecosystems of applications built on a blockchain. It aims to create an open, accessible, and unauthorized financial service system. It gives its users unlimited power over their own finances.

Decentralized finance includes digital content, smart contracts, and blockchain-based dAppy. They give users immediate and full access to their resources. They also enable faster and cheaper transactions around the world.

Brief history and origins of DeFi

From the beginning, Bitcoin was to revolutionize payment systems by making them free of controls and intermediaries. DeFi seems to be following in these footsteps, paving new paths in banking. The DeFi movement began at the end of 2018 when a network of 15 projects based on Ethereum blockchain decided to build together an independent and open financial system. Principles and common standards were defined, such as accessibility, transparency, and financial inclusion.

defi history and beginning

Today, there are many people in the world who do not and cannot have a bank account. They are cut off from some services. Decentralized solutions are coming to their aid, allowing them to join the banking community. DeFi means equal opportunities for all people with Internet access.

What are the biggest DeFi projects?

Initially, DeFi included projects such as Paradigm, MakerDAO, or OrginProtocol. With time, companies such as Compound and Kyber Network have joined. Today, a lot of new DeFi projects are being created and new ideas and ideas are being created almost every day.

The currently most important projects include the previously mentioned Compound or Maker. Most of the top DeFi applications include lending. This feature allows some users to earn extra money (the interest rate is up to 8%), and the other half of the loan and credits, regardless of the creditworthiness determined by the bank.

What are the advantages of DeFi?

The first and most important advantage of decentralized finance is that each user has full control over their own resources. Only the person who has access to these funds is able to influence them.

Such solutions are also much more accessible. Everyone who has access to the Internet can use them. The only obstacle may be local regulations, but they usually do not prohibit the use of such solutions.

In addition, users can enjoy anonymity and security. They can trade, store, and invest their assets without fear.

Decentralized finance is much cheaper than its centralized counterpart. In blockchain technology, all intermediaries are eliminated, so transaction costs are reduced.

Why intermediaries are unnecessary?

Traditional finances rely heavily on institutions (like banks). DeFi applications do not need such intermediaries thanks to well-programmed protocols that resolve conflicts themselves. Moreover, it is the user who decides to use his finances.

Smart Contracts

Most existing and potential DeFi applications include the creation and implementation of smart contracts. Their code enforces the execution of the contract. This ensures that most processes are performed automatically, making them more reliable and not requiring supervision. Thanks to smart contracts, the conclusion of contracts is quick and easy and carries much less risk.

Disadvantages of decentralized finance

DeFi has many advantages. However, it is not perfect. The performance of the application sometimes leaves much to be desired. Much depends on the performance of the blockchain network, which is slower than its centralized counterparts.

Currently, the DeFi ecosystem is heavily congested. Sometimes it is difficult and time-consuming to find the right application to solve a specific problem. Despite many security measures, there is also a risk of a hacker attack.

Another way to lose the finances kept in DeFi is a simple user error. Currently, the system requires a lot of effort from the user. The user has to enter commands and settings himself. The problem arises when you make a mistake. The changes made to the chain cannot be undone, and due to the lack of intermediaries, there is no person to verify the actions of users. This is therefore risk and special care must be taken. It is worth remembering, however, that most of the disadvantages resulting from a very early stage of DeFi development. We can expect that over time the biggest defects will be eliminated or at least minimized.

Comparison of DeFi and traditional solutions

As you can see, the advantages of using DeFi are not missing. The disadvantages, although annoying, do not exclude comfortable use of the functionalities offered by DeFi. And how do the decentralized finances compare to the solutions we are already familiar with?

Was open banking a sufficient response to the growing demand for easy and accessible online finance?

What is open banking?

Open banking refers to a banking system where financial service providers receive secure access to data through APIs, i.e. open programming interfaces.

opeing banking how does it work

API – communication between applications

API – Application Programming Interface is a link that allows different devices and applications to connect to each other. It is currently the key functionality of all solutions we use on a daily basis.

Thanks to this, with the client’s consent, banks provide access to his payment accounts to licensed third parties. In practice, this means that, for example, when seeing a tour offer, we can immediately see the option of taking a loan for it, directly from the travel agency (even though it is de facto taken from the bank).

What is the difference between DeFi and Open Banking?

Open Banking allows you to create account networks between banks and other financial institutions. It is a kind of development of traditional banking services and a good step towards digitization. DeFi instead creates a completely new financial system, completely independent of the current one. Thanks to DeFi, a completely new face of online finance will be created, not just an improvement.

DeFi features

DeFi is designed to remove most barriers and simplify complicated banking procedures. The most important services to be provided by DeFi are:
Lending and borrowing, operating decentralized exchanges (DEX), asset management and operating Smart Contracts and dApps, which will automate and speed up all processes, creating open markets – allowing the free exchange of goods and services, as well as issue platforms, thanks to which creation and issue of securities would not require intermediaries.

As you can see, DeFi has very broad fields of action and has the chance to replace traditional finance in every aspect.

The future of DeFi

Decentralized finances seem to be, in a way, the natural direction of the next, after the ever wider adaptation of the cryptocurrencies. Continuous changes and improvements in both blockchains and decentralized financial applications themselves seem promising. We can already see that blockchain operation is accelerating and increasing throughput. Nevertheless, security issues can be of concern to some users, and features to protect against hackers should be further improved. However, the vision of full control over one’s finances should be so tempting that we can expect more and more interest in such solutions in the near future.

Katarzyna Małusecka

About The Author

Katarzyna Małusecka
Content Marketing Specialist

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