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Bitcoin isn't controlled by any form of government or even banks. They basically can be sent to anyone by anyone. Bitcoin is decentralized money.
Understanding this further, we have certain financial system services with us, money transfer is one of the possible services along with that additional services include loans, saving plans, insurance, etc. These are one of such services we use today to build around money and together create our financial system.
Our financial system and their services we hold on to today around money services are completely centralized. All banks, stock markets and even insurance companies and other financial institutions all of them have someone in charge of it. It could be a person, a company or an overall institution that controls and offers all of these services, basically all services rely on central authority.
This CENTRALIZED FINANCE SYSTEM or we can call it CeFi holds risks like mismanagement, fraud and corruption to name a few. To uphold these, what if we decentralized the whole financial system in the same way Bitcoin made money to be decentralized. That’s DeFi is all about making the centralized system into making it out of particular authority.
DeFi (Decentralized Finance)
DeFi is basically a financial service with no central authority. Here Decentralized money like certain cryptocurrencies that we could program for automated activities we all can use it for lending services, can build exchanges and for insurance companies for all that don’t have any owner basically not owned by anyone.
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Infrastructure of DeFi
We need an infrastructure in order to create a decentralized financial system. This infrastructure would be required for programming and running all these services (decentralized). We have Ethereum- a DIY platform for decentralised programs(Dapps). This is also known as decentralized apps.
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Through this we can write automated code, also known as smart contracts, that basically manage any financial service we would like to create in a decentralized manner(this also means we would determine the rules as to how a service would work.) Once they are put on the platform they are immutable(no control, or changeable). Once we have space/system in place for creating such apps we can start the process of building our financial systems. They hold some of the building blocks that comprise it. Bitcoin holds only very basic programmable functionality also not compatible with the Ethereum platform. Ether is compatible and programmable, although it is volatile too. We would require a stable currency to operate within the system as we are looking for building reliable financial services. So we have decentralized infrastructure, decentralized money(stable) as 2 components. When talking about stable currency, stablecoins come into place.
STABLECOINS are cryptocurrencies that are pegged to the value of the same real world asset, like the US dollar currency. We will want a stablecoin that would not use fiat money services to maintain peg(that would require a sort of central authority).
DAI Stablecoin, a decentralized cryptocurrency pegged against the dollar(US dollar value, 1 DAI = 1 US dollar), backed by cryptocurrency collateral and is overcollateralized(it covers the ETH volatility). The DeFi component next holds financial services like decentralized exchange( DEX).
DEX is operated through rules or smart contracts that allow you to buy, sell or trade cryptocurrencies. Build on Ethereum platform, no accounts signup or verification. It’s completely autonomous, free for all and no need to deposit funds into an exchange account before a trade eliminating the risk of exchange hacking. Decentralized money markets connect borrowers to lenders, borrow against cryptocurrency collateral, autonomous management of loan terms and earn interest on cryptocurrency loaned. DeFi services work in conjunction with one another, making it possible to match different services to create new opportunities. DEX enables users to be in control of all of their finances stored in external wallets, it also helps in preventing wash trading(illegal practice where investors buy and sell the same financial instruments at the same time to manipulate the market) and market manipulation through the peer-to-peer lending system.
Smart Contracts as a Single Source of Truth holds one of the primary keys of making it better than traditional finances. Smart contracts don’t require you to analyse a bunch of documents and sign them dozens of times. Smart contracts are filled automatically based on the actions you perform on the platform, and don’t require human interference until the expiration of your contract.
DeFi Advantages Include
- Transparency
- Interoperability
- Decentralization
- Free for all
- Flexibility
DeFi Risks Include
- In infancy stage
- Use cautiously with small amounts of money
- some services are partially centralized.
DeFi is a term given to a variety of decentralized services that aim to replace our current centralized financial system.
The important factor that is majorly neglected is the lower cost of business transactions. A lot of transactions are cut-down making the industry wave higher in terms of valuation. Low cost payment options come into space because of this effect. Loans offered by DeFi tend to have lower rates comparatively thus making loans cheaper to repay.
Stock Markets are open during a fixed period of time in the week, DeFi mechanism will somehow allow 24/7 trading without the interference of brokers, which otherwise may prohibit its clients from buying or selling. Technology exists to decentralize and democratize trading so all participants are treated equally through DeFi.
The way it makes faster and more secure transactions make it the talk of the town, making the financial industry valuation up. Execution of transactions takes place through the blockchain network. This is a distributed ledger processing many transactions per second and is also a very secure network.
There have been a lot of financial innovations with the coming of DeFi as it has proven to be a reliable tool, developing a ton of financial products which were previously known to be the domain of only large, licensed institutions. DeFi saving applications also make sure to provide a non-custodial wallet. With Defi apps we can enjoy permissionless, straightforward and similar many financial solutions.
DeFi in Insurance and Asset Management, it holds certain policies as there are no safeguards against errors(custodians errors etc). They may be applied to pools, personal wallets or smart contracts for lending and staking. The costly traditional insurance policies are something we get rid of because of the defi insurances coming into play. World’s economy could be re-invented with the well-equipped DeFi.
Disclaimer: This blog has opinionated information which does not make us liable for anything.