Decentralized Finance (DeFi) is a blockchain-based alternative to traditional, centralized Finance. Being decentralized means that there are no banks, financial institutions, or other third parties governing or managing payments. DeFi has grown as a blockchain platform, building and expanding upon the original decentralized premise of Bitcoin.
Today, DeFi platforms exist as alternatives to most traditional, centralized forms of Finance with DeFi payments, exchanges, wallets, lending platforms, insurance, and more.
Defi As Part Of The Cryptocurrency Industry
Cryptocurrency started its journey in 2009 with the launch of Bitcoin. Meant as a means of quickly and cheaply transferring value between users, it took a couple of years for the world’s largest cryptocurrency to gain market traction. From there, it took until the 2017 launch of MakerDAO, a decentralized lending platform based on the Ethereum network, for the world to start seeing the potential benefits of decentralized Finance (source: https://www.techopedia.com/kr/cryptocurrency/best-defi-2-0-coins).
According to cryptocurrency expert Soobin Choi, recent developments have seen the implementation of DeFi 2.0 platforms, which further improve factors like transaction speed and costs while also bringing additional features to the market.
What Is DeFi?
When we make payments, take out insurance, or conduct other financial transactions using traditional Finance, we involve banks or other institutions. These groups are responsible for ensuring the validity and completion of the transactions. They can also be called on if there is a dispute or to help facilitate certain transactions. All transactions are recorded on the institutions’ systems, which are closed systems.
With DeFi, there are no central bodies: no banks, no lending companies, and not even centralized systems. Smart contracts are established on blockchain networks, and transactions are completed automatically. In a lot of cases, using these platforms requires the purchase of native coins that pay gas fees for the use of the network.
Because everything is automated, transactions can be completed instantly, and because no central groups are managing the transactions, costs tend to be lower, and terms can be directly agreed upon by the end parties. Effectively, DeFi aims to put financial power into the hands of users rather than into banks and institutional lenders.
Smart Contracts
Smart contracts form the basis of most DeFi transactions. These are contracts in the sense that all relevant parties agree to the terms of a transaction. And because the contracts are smart, they are set up on blockchain networks so that they start, operate, and finalize automatically when specific criteria have been met.
A very simple example of a smart contract is a cryptocurrency traded on a decentralized exchange. If a person agrees to buy exactly one Bitcoin from another user for $100,000, a smart contract is established.
When both parties have initiated a transfer of the relevant funds from their crypto wallet, the smart contract registers and enables the passing of the funds to the other parties. The whole process can take a matter of seconds and does not require the use of an intermediary.
Smart contracts can be a lot more complicated. For example, DeFi lending enables a user to lend an amount of cryptocurrency to another user. The user that borrows that cryptocurrency agrees to pay a fee, or interest, on the amount borrowed over a given term.
The borrower might agree to borrow 10 Ether for 6 months and will pay 1 Ether in interest. A smart contract is established on the blockchain, and when both parties agree to the terms, the borrower receives 10 Ether in their wallet. Six months later, the contract automatically transfers 11 Ether from the borrower to the lender.
Other examples include cryptocurrency staking and even decentralized insurance. Contracts can involve multiple parties and many different facets of a deal.
How Is DeFi Better Than CeFi?
Centralized Finance is well established, and it has the backup of a central group to govern its use. Most people, although not all, have access to centralized finance applications and transactions. However, there are certain benefits decentralized Finance offers compared to centralized.
Transparency
Smart contracts and decentralized transactions are recorded on the blockchain. They are visible so that anybody with details can view the records, effectively ensuring that a deal is progressing as planned. This level of transparency is not found in centralized Finance, where records are kept secure. It can leave parties to the transaction unsure of how things are progressing.
Anonymity
Despite transactions being visible on the blockchain, they do not include personal details. The sender, recipient, and other parties involved in the transaction are not named, which means everybody retains anonymity. The records are immutable, which means they cannot be altered or deleted once they have been added. This does mean that certain transactions, like refunds, can be trickier to instigate, but it also means that all transactions are final, so it can eliminate chargeback fraud and other activities.
Access For All
Decentralized Finance involves transactions that are agreed upon and completed primarily by the two end parties. Even where a platform, like a decentralized exchange, is used, this does not act as an intermediary. It is down to the individuals to determine the details and agree to the transaction.
This means that even users without access to traditional banking facilities can benefit from decentralized financial services. One of the key benefits of cryptocurrency is that it offers services to unbanked citizens.
Control
Because there is no central organization, it means that it is the users who retain control over all aspects of decentralized Finance. The instigating party makes an offer, and another party chooses whether to accept the deal. Only stipulations set by the two parties are considered. In contrast, when you want to send money via a bank or other financial institution, some parameters must be met.
There might be minimum transaction sizes, a limit on what types of funds can be sent, and more. In some cases, these institutions only deal with transactions in their own country or of certain types, and this can lead to the use of yet another organization.
Reduced Fees
The more central organizations used in centralized Finance, the more fees will be payable. As such, sending money overseas can prove especially costly. Borrowing money from lenders not only attracts interest but can also include administrative and other fees. Although DeFi users do have to pay gas fees to use the network, these costs are minimal, and some networks operate with no gas fees.
24 Hour Access
Banks close at the end of the working day, and they generally don’t initiate or complete payments at night or over weekends. When using centralized Finance, users have to abide by these times and other limits, but with decentralized Finance, there are no such limits. Even centralized exchanges operate 24 hours a day. As long as the other party agrees to the setting up of a smart contract, everything can be completed at any time of the day.
Conclusion
Decentralized Finance dispenses with banks and central institutions to give power to users. It offers transparent, fast, and inexpensive financial services. From decentralized exchanges to lending platforms, DeFi solutions can offer products that would normally be unavailable to a lot of people. It can also cut costs associated with traditional Finance while broadening its appeal and making a wider range of products more accessible to the general public.
