What is DeFi?
At its core, DeFi is a set of financial applications put together on blockchain technology — predominantly Ethereum though not only— that disrupts traditional banking. In contrast to traditional banks that need middlemen in transactions, DeFi protocols are operated through smart contracts without intermediaries. These smart contracts minimize the need for banks, brokers and other intermediaries in financial transactions helping to establish a peer-to-peer nature.
DeFi, in other words, enables the user to directly receive banking services by delivering transparency and accessibility with decentralization.
How Does DeFi Work: The Bankless Future
Centralized institutions such as banks, insurance companies and government agencies are used in the operation of traditional finance (TradFi). DeFi, in contrast, runs on decentralized open-source protocols. These protocols offer a number of services like:
• Lending and Borrowing: Other platforms like Aave or Compound allow users to make their assets available for lending in returns with interest, and borrowers could use these common asset pools (no credit score is needed) if they were looking℡for loans.
• Trade: Users trade individual cryptocurrencies with each other directly on platforms like Uniswap, SushiSwap via liquidity pools (rather than a central exchange)
• Stablecoins: These cryptocurrencies designed to have a stable value that is pegged to another asset say fiat money using smart contracts and used by individuals as an alternative way of saving wealth without the volatility characteristic in many other crypto assets.
Examples of such applications are also reducing the cost and enhancing accessibility in underserved markets by eliminating intermediaries.
The Advantages of DeFi
• Accessibility: DeFi is global by nature, providing financial services to anyone in the world with an internet connection and without regard for location or social class.
• Transparency: DeFi platforms make every transaction public on blockchain, which provides full transparency and reduces the risk of fraud.
• Control: When you use DeFi, your assets are under your control — unlike with a larger financial institution.
• Innovation: open-source protocols continue to redefine the DeFi space, launching new innovative products and reshaping traditional finance.
Challenges in the DeFi Space
DeFi offers numerous advantages, but it also comes with challenges such as:
• Scalability: The higher the number of users that come to DeFi platforms, the more congested the networks become such as Ethereum and this congestion can result in increase fees on transactions and slower transaction time. But Layer 2 scaling and new blockchains like Solana are solving this.
• Regulatory Uncertainty: For the most part, DeFi operates outside of today’s regulatory environment and that can be both a competitive advantage an exposure to increased risk. FirestartingRegulators around the world are moving in for a closer look and more legislation is likely to reshape industry.
• Security Risks: Despite the security offered by DeFi systems, there are still vulnerabilities that could be detected and abused. Millions of USD have been lost in recent attacks, and this underscores the importance of security audits as well as sound protocol design.
A Decentralized Outlook to Future Banking
DeFi is the new frontier of how we think about money and finance. DeFi — which eliminates the middleman and opens up financial services to anyone who has access to an internet connection via smart contracts on a blockchain, allows traditional non-banking individuals bank themselves. However, as the tech matures we will likely see tighter integration with traditional finance systems and better security/scalability/usability.
Decentralized Finance, in a world where technology is disrupting the status quo of traditional institutions DF has quickly emerged as banking’s newest and hottest frontier. Is The World Ready For Banks To Become Unnecessary?
Conclusion
For all the hype, DeFi is much more than a buzzword; it represents a radical new path to decentralized, free and transparent future of financial services. For a tech enthusiast, investor or even someone curious about the future of finance looking in — here is an unpolished window staring at how banking can reshape and guess what- it might just do away with banks from our lives.
References
1. Zetzsche, Dirk A., Douglas W. Arner, and Ross P. Buckley. “Decentralized finance.” Journal of Financial Regulation 6.2 (2020): 172-203.
2. Schueffel, Patrick. “Defi: Decentralized finance-an introduction and overview.” Journal of Innovation Management 9.3 (2021): I-XI.
3. Chen, Yan, and Cristiano Bellavitis. “Decentralized finance: Blockchain technology and the quest for an open financial system.” Stevens Institute of Technology School of Business Research Paper (2019).
4. Michalikova, Katarina Frajtova, and Adela Poliakova. “Decentralized finance.” SHS web of conferences. Vol. 129. EDP Sciences, 2021.
5. Chen, Yan, and Cristiano Bellavitis. “Blockchain disruption and decentralized finance: The rise of decentralized business models.” Journal of Business Venturing Insights 13 (2020): e00151.
