This article is contributed by Mr. Rohit Gajbhiye (CEO, Financepeer).
Imagine being able to lend and borrow money without worrying about bank holidays and bank hours? Is such a future possible with minimal intervention of banks for lending and borrowing?
Believe it or not, but this is the future that lies ahead for India’s banking and financial sector. According to MejoresApuestas.com, the DeFi business is worth around $85 billion in September 2021, up from $19.5 billion in September 2020. Traditional finance firms are becoming engaged in the field of DeFi. PayPal, for example, has stated that it may integrate DeFi services onto its platform. Simultaneously, Bitwise Investments announced the opening of new funds to invest in the Aave protocol and the Uniswap decentralized exchange. Such funds enable investors to invest in DeFi without having to purchase tokens or bitcoin.
So, what exactly is decentralized finance? The concept of decentralized finance, or DeFi as referred to in common parlance, refers to financial services that are fully run on blockchain networks rather than through middlemen such as banks. It manages financial transactions using bitcoin and blockchain technologies. DeFi aspires to democratize finance by replacing historical, centralized institutions with peer-to-peer partnerships capable of providing a broad range of financial services, including daily banking, loans, and mortgages, as well as complex contractual agreements and asset trading.
The WHY? Traditional Centralized Finance v/s decentralized finance
Today almost every element of financial services is handled through centralized systems that are run by regulating organizations and gatekeepers. Governments and financial organizations can shut down markets or like in February 2021 when trading had to be halted at the National Stock Exchange (NSE) due to a technical glitch. Trading hours are frequently restricted to business hours in a given time zone.
The HOW of DeFi - How DeFi Works?
DeFi turns the present system on its head by reimagining financial services as decentralized software apps that never touch user cash. So if an applicant needs a loan, he or she can smoothly avail the loan amount by showcasing bitcoin as collateral. This generates a "smart contract" that locates an individual’s money among the monies made accessible on the blockchain by other individuals. With this smart financial ecosystem, financial institutions can do away with a bank loan officer, loan rejections, long list of documents submission, etc. DeFi enables the interchange of trustworthy data across a system, therefore lowering the barriers to corporate financial services.
Transactions conducted in this manner are more efficient, flexible, secure, and automated than those conducted in traditional finance. Furthermore, DeFi removes the gap between regular consumers and affluent individuals or organizations, who have access to a broader range of financial goods.
Today, an individual may deposit money in a savings account and get a fixed interest rate on it. The bank then lends the same money to other customers, and the interest rates are on the higher side, thus, pocketing the profit. People can use DeFi to lend their funds directly to others, avoiding the loss of profit and earning the full return on their investment. One of the biggest advantages of this system is any individual may become a member of a DeFi lending pool and is eligible to lend money to other applicants.
The Risks - Is DeFi Safe?
Decentralized Finance, like any other emerging technology, is not without risks. Even gold deposited in bank lockers is risky and is vulnerable to theft, but customers have been opting for such services. Considering DeFi has thrived in the absence of laws and regulations, users may have little chance of redressal if a transaction goes wrong. While a blockchain is almost hard to hack, other parts of DeFi are vulnerable to hacking, which can result in money theft or loss. Concerns have also been raised about legislative ambiguity, scalability, security and technical hazards (software flaws and hackers), governance of decentralized apps, and a variety of other issues. An individual’s adaptability and knowledge of using technology is a great factor, as lack of knowledge can pose a risk.
Decentralized Finance leads to better user experience, and helps in emphasizing design and usability and bringing open finance to a wider audience. DeFi is just another example of how software built on open standards has the ability to dramatically alter the game. However, in order to achieve the full potential of this new financial ecosystem, both developers and regulators will need to improve their own performance.
FAQs on Decentralized Finance
What is Decentralized Finance?
Decentralized Finance (DeFi) is a blockchain-based form of finance that doesn't rely on central financial intermediaries like brokerages, exchanges, or banks to offer traditional financial instruments. It instead utilizes smart contracts on blockchains.
What are examples of DeFi?
DeFi is specifically associated with the Ethereum blockchain and all of the cryptocurrencies built on it.
What are Decentralized Exchanges?
Several cryptocurrency exchanges such as Coinbase function as centralized platforms to connect cryptocurrency buyers and sellers. Decentralized exchanges (DEXs) such as MDEX use smart contracts to perform the work of centralized exchanges, with the smart contracts providing pricing for each counterparty at or near prevailing market prices.
Is DeFi safe?
DeFi is still an emerging technology which means that negative outcomes can unexpectedly occur. An important point to note is that Defi is not regulated by any central organization/government or banks. Despite all of this, DeFi's accessibility,, functional autonomy, efficiency, and speed attract investors/traders and other stakeholders.