What Is Decentralized Finance?

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What is Decentralized Finance?

The death of modern-day banking is in the making. And its inevitable demise is spurred on by innovation in DeFi that renders the former’s objective redundant. With DeFi, traditional banking is dead. For bankers themselves, it’s either evolve or die.

This threat to banking is why there’s such an uproar regarding global crypto adoption. The bankers don’t want to lose their jobs. The government isn’t interested in losing control. And the institutional go-betweens want to keep making a profit.

Decentralized Finance, or ‘DeFi‘ as more commonly known, is a broad term for various financial applications, services, and transactions on the Ethereum blockchain.

Decentralized finance as a developing financial infrastructure aims to erase the need to approve financial transactions by a government agency or central bank. 

DeFi intends for centralized institutions to be replaced with a peer-to-peer relationship that delivers financial services ranging from mortgages and loans to asset trading and complex contracts.

With decentralized finance, you get faster everyday banking services like lending and borrowing, trading derivatives, buying insurance, and more; however, there is no interference from a third party or any paperwork. 

DeFi expands the primary premise of digital money by creating an alternative financial market that is open, fair, free, and available to anyone connected to the Internet.

Decentralized vs. Centralized Finance

Today, nearly every facet of banking, including lending, borrowing, or trading, is governed by centralized structures, supervised by gatekeepers and regulatory bodies. 

Before ordinary customers can access financial services such as mortgages, bonds, and loans, they will have to haggle with several financial intermediaries. 

Customers have limited direct access to financial and capital services due to the rules for the centralized finance world being set by a regulatory body such as the Securities and Exchange Commission (SEC). 

Lenders, exchanges, and banks are middlemen who earn a portion of every banking and financial transaction as a profit, and consumers cannot evade them. 

Decentralized finance contests centralized finance by eliminating the need for middlemen and authorizing regular people through open, pseudonymous, peer-to-peer transactions.

Peer-to-peer means trades and transactions that are not routed through any centralized structure but occur between two people without any intermediary.  

Benefits of Decentralized Finance

There are several different benefits to decentralized finance, some of which are:

  • Anonymity: In decentralized finance, you are not required to provide personal or private information like your name, location, or email address. Consumers can operate under a pseudonym.
  • Open: Consumers can access decentralized finance services by simply creating a DeFi wallet. Opening an account is not needed, and neither is applying for anything.
  • Transparency: Each party involved is privy to the full detailed set of transactions. Private and centralized corporations and organizations seldom grant this kind of transparency. 
  • Promptness: Interest rates are frequently updated, as fast as every fifteen seconds; this is significantly more impressive than conventional financial services like wall street. 
  • Flexibility: Consumers can move their assets anytime to anywhere without seeking permission, paying exorbitant fees, or waiting for lengthy transfers to be completed.

What to do with Decentralized Finance?

Engaging with decentralized finance is typically done via schemes called “protocols” and decentralized apps “dApps,” the majority of which are currently running on the Ethereum blockchain. 

Some of the different ways you can engage with decentralized finance include are not limited to the following:

  • Get a loan: One of the loan packages you can get in defi is flash loans. Flash loans are exceptionally short-term loans you borrow and payback in the same trade currently not offered by conventional finance institutions. With decentralized finance, one can instantly acquire a loan without filling in numerous paperwork.
  • Trades: Defi allows peer-to-peer trading of particular cryptocurrency assets, similar to you selling or buying these assets without any brokerage.
  • Borrowing and lending: DeFi enables you to borrow some crypto assets to trade with and make a profit. You can also earn passive income by lending out crypto assets, not in current use and acquiring rewards and interest per minute; however, this cannot be done more than once a month.
  • Savings: DeFi earns you better interest rates than centralized financial services. By providing alternatives to traditional savings accounts, you can store some crypto for the future. 
  • Derivatives buying: This is the cryptocurrency version of futures contracts or stock options. Defi allows you to make short or long bets on specific assets.

How Decentralized Finance is Used

DeFi protocols and Decentralized Applications are the two ways the def world is being powered. These protocols and dApps manage transactions in Ethereum (ETH) and Bitcoin (BTC), the two major cryptocurrencies. 

Although Bitcoin exceeded in popularity, Ethereum is vastly adaptable to a broader range of uses. This means that most of the protocols and dApps are Ethereum-based. 

These protocols and decentralized applications are being used in the some of the following ways: 

  • DEXs: Decentralized exchanges foster peer-to-peer transactions and allow users to maintain custody and control over their money. Currently, centralized exchanges like Gemini and Coinbase are what most crypto investors use.
  • Conventional financial transactions: Decentralized finance facilitates financial transactions, from payments, insurance, and trading securities, to borrowing and lending.
  • Yield harvesting: Through defi, uncertain investors can lend crypto and probably reap huge rewards when the coins a decentralized finance platform pays them to appreciate quickly.

Downsides and Risks to DeFi

As emerging a phenomenon defi is, however, several risks are associated. Because decentralized finance is a recent innovation, widespread or long-term use has not stress-tested its capabilities. 

Additionally, defi is also gaining interest from regulatory bodies who are inquisitive about the systems it’s laying in place. These are some of the risks involved in DeFi: 

  • Zero consumer protection: Decentralized finance has flourished in the deficiency of regulations and rules. However, this likewise means little to no recourse should a transaction go awry. 
  • Digital threats: Although it is next to impossible to alter a blockchain, there are several other facets of DeFi which are in huge danger of hacks, leading to loss of funds and theft. The reliance on software systems by decentralized finance makes it susceptible to hacks and thefts. 
  • Private keys: With decentralized Finance and cryptocurrency, the wallets you store your crypto assets need securing. 

Private keys are lengthy, distinctive codes known only to the holder of the wallet; this private key is what secures a wallet. Loss of a private key means losing your funds, as there is no means to reclaim a private key.

The future of decentralization finance is looking bright, from erasing middlemen to increasing the use cases of digital assets. Although there are some hurdles, defi is slowly catching up to conventional financial services.

What is Decentralized Finance?