The world of finance as we know it has not changed for a considerable stretch of time. Maybe, the way we access it has changed from simple papers to smartphones, but the entire ecosystem has remained constant. Banks have exercised power over our funds, and transactions take a long time to get executed, even during the era of superfast Internet.
The delay can be attributed to the intermediaries involved in executing the transactions. In other words, The responsibility of executing these transactions lies with centralized institutions like banks.
With the birth of Bitcoin, the concept of banks has been partially rendered obsolete. This currency can exist without a bank and purely as a digital entity. While this can be seen as a small flicker, efforts have been on the way to reinvent finance, and this new financial ecosystem will not have any centralization or intermediaries. This new type of finance is called decentralized finance, commonly abbreviated DeFi.
What is DeFi?
DeFi(Decentralized Finance) is an ecosystem of different applications designed to operate on the blockchain and execute almost all operations that can be considered necessary for today’s financial world. The operations include but are not limited to transactions, exchange, lending and borrowing, and even purchase of commodities.
What Advantages Does DeFi Bring?
At the epicenter of DeFi lies the smart contract. A smart contract is a program designed to automatically execute certain transactions when certain conditions are met. Generally, Ethereum is the most preferred blockchain for building smart contracts.
These smart contracts are designed to operate without any human intervention. Smart contracts on its side, DeFi brings the advantage of minimizing human errors and delays. In addition, since the process is automated, the transactions can be expected to happen at a faster rate. Above everything, a great advantage under the hood is that your transaction details will not be made available to any centralized authority.
The smart contract can be programmed in such a way that a particular person can be credited with a certain amount if there is, let’s say, for example, a delay in the takeoff of their booked airline, without a hiss.
The possibilities with DeFi
If DeFi intends to replace the existing financial ecosystem, it needs to come out at least, provide all the services that the current financial system provides. This is made possible through decentralized applications. DeFi presents a wider opportunity for decentralized applications to execute various financial operations.
Decentralized exchanges (DEX):
Cryptocurrency exchanges have established themselves as one of the most practical manifestations of the entire Crypto world. The Forbes magazine has concluded that the cryptocurrency exchange business is the most lucrative business for any aspiring blockchain entrepreneur. However, most mainstream exchanges are heavily centralized, and it is centralized to an extent that the user does not have access to the private keys of the crypto wallet.
With a decentralized exchange, at no point in time does the exchange have control over the funds of the user. In fact, instead of connecting a buying order to a selling order, a decentralized crypto exchange connects the buyer and the seller to execute the transactions. The trust is established by a smart contract-based escrow.
Lending and borrowing are essential elements of today’s finance and it is effectively taken care of by loans. In the decentralized realm, lending and borrowing can be taken care of by smart contracts. DeFi lending and borrowing happens completely on a peer to peer basis, without involving any intermediaries.
To lend, it is only natural that one must have a repository of the asset that needs to be lent. In this case, the “asset” it’s called a liquidity pool. A liquidity pool is a repository of multiple tokens guarded securely by a smart contract. People can deposit the crypto-cash that they do not use through a smart contract into this liquidity pool. Another user who intends to borrow some money can borrow from this pool. In essence, the liquidity pool functions as a bank.
If a bank can earn through the interest levied on the loan amount, people who deposit their money in the liquidity pool are also eligible to earn through the interest. This process of earning money from decentralized lending platforms is called yield farming. It is one of the most lucrative methods to make money in the DeFi realm.
Some DeFi platforms even go ahead and entice users to participate in their platform by giving away free tokens. With the first token serving as the bait, liquidity keeps propagating in the platform. This method it’s called liquidity mining, and it is considered to be one of the many methods of yield farming.
Most DeFi applications are open source. This would mean that it is publicly available, and these apps can be used as the foundation for building new apps with the same code. This property is known as composability. If we extrapolate this attribute, the entire blockchain can be filled with decentralized applications designed to execute various DeFi operations. By design, they integrate with each other seamlessly like blocks of Lego, giving rise to the term “money Legos“.
Crypto is always affected by the volatility epidemic. If cryptocurrency needs to find practical application as an instrument of a transaction, it needs to achieve price stability. This has been adequately achieved by the introduction of stablecoins.
A stablecoin is a cryptocurrency whose value is pegged to a real-world asset. The asset can either be a commodity like gold or a Fiat currency like the United States dollar. With the biggest disadvantage of cryptocurrency getting addressed, it will not be long before crypto starts to cement its position as a reliable instrument of transaction.
Although the move might sound sinister on the surface, it holds practical applications. It is quite known that a particular blockchain can only handle a particular type of cryptocurrency. To ensure that the most prominent currency, the bitcoin, finds its relevance in the most preferred blockchain for DeFi, Ethereum, bitcoin can be “wrapped“ with a cloak of ETH, so it can be used on all DeFi transactions that happen on Ethereum.
DeFi has a lot of extended applications like production markets for elections, and all these things can be executed without intermediaries and the associated costs. It seems that the case is strong for DeFi to replace the currently existing traditional finance.
Decentralized applications are expected to spearhead this transformation. If you would like to be a part of this revolution by developing your own DeFi applications, all you need to do is get in touch with the company that specializes in decentralized finance development. The DeFi development company will take care to understand your business requirement and create perfect DeFi solutions for you.