Those who are unfamiliar with the terms ‘decentralized finance’ and ‘blockchain’ may already have so many questions: What is DeFi? How does it work? Why does everyone talk about it, and why is it as great as everyone claims it to be?
Recently, there has been a lot of talk about DeFi. Public interest in the topic is significantly growing year-on-year due to its possible impact on the current financial systems.
In this article, we will go through everything you need to know about decentralized finance, and the effect it has on the future of finance.
What Is Decentralized Finance and How Does It Work?
Decentralized Finance or DeFi is an experimental type of finance that uses blockchain technology and is most commonly found on the Ethereum (or Ethereum-based) platform. It is the opposite of centralized finance, such as banks, brokerages, and exchanges.
To show the recent popularity of DeFi crypto protocols, more than $11 billion have been laid down during October, which is a serious rise compared to the rest of 2020.
DeFi systems allow people to borrow funds from other users, trade cryptocurrencies and create saving-like accounts. Some DeFi apps offer high-interest rates, although they are also prone to higher levels of risk.
DeFi applications use the building blocks of Ethereum. Ethereum, a platform well-known amongst the fans of blockchain, is the second most popular platform for crypto exchanges on the planet. It offers smart contract functionality and even its own coin, the Ether. Its main difference from Bitcoin is that it is much easier to build decentralized technologies that aren’t based on simple transactions.
Ethereum’s smart contract functionality is the key to the smooth running of DeFi applications. Generally, smart contracts complete transactions automatically, but they can only do so if a certain condition is met. For example, if users wish to send money to friends, they have to meet a certain requirement, like completing a task or confirming a receipt. This is the one way of ensuring reliability for DeFi.
What Are the Benefits of Decentralized Finance?
The main advantage of decentralized systems is that they don’t need a middleman to provide security. In “regular” finance, these institutions are usually banks, however, DeFi apps don’t need a mediator because they are based on blockchain.
The answer to every possible dispute is written in code and stored in the network. This means that all users maintain control over funds and information at any point in time. This process lowers costs and results in a smooth financial system.
Blockchain writes down and records all the data, and then spreads that data across the network or nodes. This removes any type of censorship, control, intrusion, or even shutdown of any kind.
DeFi is an open ecosystem, which means that it allows all types of users to join the network. This also includes those that don’t have access to traditional financial services.
Advantages of DeFi are tightly connected to the benefits of using blockchain, like:
- Decentralization — No third-party control over transactions
- Full control — Users have end-to-end control over their funds
- Time-saving — It is easier to use and access
- Cost-effectiveness — Less costly than traditional banks and services
- Increased cybersecurity – data blocks cannot be erased or altered
- Transparency — Transparency levels are easily defined
- Permissionless to participate — No KYC, credit scores; same rules apply to every user
It is clear why decentralized finance and blockchain have found their uses in many areas of business and finance.
What Are the Use Cases for Decentralized Finance?
Thanks to blockchain, decentralized protocols and financial instruments are becoming much more than a simple money transfer. They have opened a whole new world of possibilities for finance, and could become a game-changer for the current financing system. Here are some of the examples of DeFi system use:
DeFi platforms give you a chance to be the guardian of your own funds — in this case, cryptocurrencies. There are many crypto wallets available on the market, like our own Casi Wallet and Apego Wallet. These help you with anything, from buying, selling, and transferring cryptocurrencies, to earning interest on various digital assets.
You own everything, such as private keys and passwords, and store it on your device. You are the only person that can access them.
The decentralized root of the Ethereum blockchain ushers in a new era of compliance. Its main benefit lies in the analysis of participating addresses instead of focusing on their identity. These KYT or know-your-transaction structures guarantee lower risks and real-time protection against crime and fraud.
Thanks to transparency, which lies in the very nature of blockchain technology, it is easier to analyze network activity. Decentralized Finance protocols mostly aid the processes of risk management and discovering financial opportunities.
DeFi hosts tools that can keep track of the value in DeFi protocols, compare yield and liquidity, or assess platform risk.
A key advantage to decentralized exchanges (or DEX) is that they run without any central authority. This allows users to exchange products and services peer-to-peer on a global level and keep control of their funds. The main benefit of DEX is lowering the risk of price manipulation, theft, and hacking.
It is also possible to get token project access to liquidity, often without any fees. This is usually better than what you can find in centralized exchanges. There are also a few exchanges that apply a level of decentralization. In such a case, centralized financial systems will act as a host, but it will not store private data.
The Decentralized Autonomous Organization follows transparent rules encoded in any Ethereum or Ethereum-based network. It removes the need for having any administrative entry or centralized body of control.
Borrowing and Lending
Some of the most widely used protocols across DeFi ecosystems are borrowing and lending. They operate peer-to-peer in both ways, and there is a myriad of protocols that allow clients to transfer funds with an interest. The protocol uses smart contracts and matches lenders and borrowers. Then, it calculates interest rates based on the sum that they are exchanging.
Similarly, the user can send or receive funds as they would with traditional types of payments.
These are just some of the many applications of DeFi, and you can use it for nearly anything else you can imagine. Many marketplaces already allow cryptocurrencies as a payment menthod. Today, DeFi is also a platform for prediction markets, tokenization, savings, margin trading, and much more.
A Word on Our Projects
TheBlockBox owns a couple of projects that have contributed to the DeFi industry. The first one is Vesto, which is a global digital currency banking platform. Vesto aims to have a next-gen fintech banking platform with the use of blockchain, DeFi, and stable coins.
It offers a multi-signature wallet, supports custodial services, and is fully integrated with USDC, MakerDao, Compound, and Ray stable coins. As you already know, most DeFis are based on the Ethereum network, so Vesto also supports ERC-20, ERC-721, and ERC-777 smart contracts.
9th Gear Technologies is the only B2B marketplace that offers same-day Foreign Exchange (Forex) transactions. It was the banks that have previously owned and performed such transactions. Now, it is open to new users, who can complete these transactions can be completed individually and within minutes.
9th Gear is an FX trading market platform focused on trading foreign currencies like USD, EUR, GBP, and many others.
These are just some of the examples that show the growth of DeFi, with many exciting possibilities.
How Is DeFi Different From Fintech?
To simplify, DeFi is fintech, but fintech is not necessarily DeFi. Fintech or financial technology is any technology that aims to improve traditional financial services and methods. This means that fintech is prone to centralization or could work with fiat currency.
The main differentiating factor that set DeFi apart from traditional finance is blockchain and cryptocurrency. Blockchain technology focuses on transparency and decentralization, slowly removing financial giants from the bigger picture. This unfortunately means that users carry a greater risk of error, as the blockchain permanently records transactions that cannot be altered.
We can easily say that DeFi falls under the broader term of fintech. It is still a lot younger, and it has to prove its worth. Global investment in fintech grew 2,200% between 2008 and 2015, and we can expect an even bigger growth. As users begin to understand its benefits, so will the big industry leaders decide to tap into alternative technologies.
Link Between BTC and DeFi
Whenever someone mentions cryptocurrencies, the first thing on everyone’s mind is Bitcoin, the reason being its pioneer status of cryptocurrency. It the first-mover which brought the new, decentralized technology into the mainstream. Unfortunately, the same trend is not observed in DeFi. The main reason for it is that its platform – Ethereum – is the most popular Altcoin.
Recently, RIF or RIK Infrastructure Framework has decided release the Bitcoin-based smart contract protocol RSK. This decision has stirred the crypto world, and in the last seven months, it has been moving towards DeFi space. Developers believe that it will bolster services on the BTC chain.
A few months ago, WBTC or wrapped Bitcoin managed to find its place in DeFi. Now, users can now bring their BTC to the Ethereum blockchain by turning their BTC to WBTC. Bitcoin is still strong on the market, and it is yet to be seen whether BTC will become a trend.
BTC users already have a chance to open bank accounts, wallets, or trade whenever they want. Hence, DeFi offers one biggest advantages to the industry through decentralized borrowing and lending. We are yet to see its future effect on other industries.