The world of financial services is seeing quite a bit of changes in the current period. Financial institutions are adopting technology, adhering to further liquidity requirements from regulators, and ensuring some form of stability in the financial system.
But the universe of finance is no longer the same. There are various forms of volatility due to aspects related to the Great Financial Crisis and previous market and economic declines.
Due to many factors, people are diversifying their investment in financial products.
Individuals are realizing that the traditional financial system may not provide them with the ideal results that they need to survive and thrive.
People are starting to wonder about the value of fiat currencies like the USD, the CNY, the YEN, and other government backed currencies that are manipulated by respective central bank institutions.
For instance, interest rates around the world have headed down over the past two decades. Many investors and financial luminaries from Ray Dalio to Peter Schiff speculate that interest rates will stay that way for quite some time.
Of course, this is a problem for many different individuals and institutions in traditional finance.
Many people have heard about bitcoin, the leading peer-to-peer currency and crypto in general but they do not know all about the various nuances present within the emerging blockchain industry.
While bitcoin serves as a decentralized store of value for many people around the world, many different trending blockchain projects are stepping in to add more value to individuals.
Sure, one can easily gain exposure to crypto assets through Coinbase, defi services, defi protocols, and decentralized exchanges. But what are these assets all about and why do they matter?
Well, if you keep up with new technologies or simply want to carry out a major financial transaction, you might want to look further into the field of decentralized finance (DeFi). With many institutions introducing this method for their ongoing transactions, the descriptor seems inescapable for anyone on the web.
So what is decentralized finance, anyway? Thankfully, the answer is not difficult to understand. With a straightforward description and a few clarifications, you can learn exactly what is DeFi and why it is lauded as the future of finance.
To start on this journey, here’s a lowdown on everything about decentralized finance.
What is Decentralized Finance in the Crypto Sector?
Decentralized finance refers to financial transactions that are carried out on a blockchain network which is not centralized or fully-controlled by a single entity. This means that in order for a transaction to qualify as being part of DeFi, it has to be performed on a public network powered by blockchain technology.
To give you a quick refresher on blockchain technology, this interconnected network of information uses highly encrypted security mechanisms. This makes it difficult to hack or modify information.
When blockchain platforms use a public ledger such as those utilized in cryptocurrencies, all transactions are also listed publicly. This makes it nearly impossible for anyone to alter their financial history and makes way for more transparency in the right setting.
As a result, the answer to what is DeFi can be as simple as performing your financial transactions on a decentralized blockchain network. This means that any institution, business, or individual who performs their financial transactions this way can be termed as being a part of decentralized finance.
What Are the Benefits of Using DeFi ?
There are several benefits of using DeFi that range across cost-efficiency, processing time, and level of reliability. Due to these reasons, DeFi is hailed as the future of finance by many of those who work in the financial sector.
Once you have learned what is decentralized finance and how it works, it also gets easier to know about these advantages. It is because almost all of these benefits stem from the blockchain technology, which is the underlying power behind DeFi.
Automated Transactions through the blockchain
Through blockchain technology, many decentralized networks integrate essential functions and tools within their foundation. Unlike conventional transactions that need a third-party such as bankers or brokers to oversee the process, this mechanism works on its own with the utmost reliability.
This is possible due to smart contracts, which can be easily executed through a decentralized blockchain network. Once set or created, these smart contract transactions execute the related financial transactions in an unbiased manner. Whether you are buying an asset, selling something, or investing funds through blockchain, this gives you the peace of mind that your finances are protected.
For instance, if you decide to take out a loan through blockchain after learning what is DeFi, you can use a smart contract-based system to find a lender and borrow money. The smart contract can handle the terms of your loan repayments, including your monthly installments and overall tenure. If you fulfill the terms, you can remain in good standing with your lender and the network. Otherwise, you might be subject to penalties that you agreed to before the time of your loan disbursement.
Direct Deals on the blockchain
The removal of intermediaries is one of the biggest advantages of using smart contracts or similar features. These third-parties may comprise different professionals that range from loan agents to bank managers. Once you learn what is decentralized finance, you can instantly identify these roles within a financial transaction. To be more precise, you will be able to note their absence in decentralized networks.
This mechanism gives you a direct way to connect with the other party in your intended transaction. For instance, if you are trying to make profit by lending funds to someone, you can find a potential borrower and execute the transaction through the DeFi network itself. Similarly, if you are looking to gain investment for your business, you can find investors or lenders through the same approach.
The absence of third parties leads to more than one benefit. First of all, it allows you to carry out your transactions in a faster way. Secondly, it lets you connect with different parties on your own terms. Last but not the least, it provides you with a low-cost mechanism that steers clear from third-party service fees. Other advantages include automation, unbiased execution, and prevention of human error.
Lower Costs through the Blockchain
When used in traditional cryptocurrency networks, blockchain technology is often regarded as being costly. But that is not always the case. In fact, the technology can often cut down the costs for many decentralized networks. In decentralized finance, this becomes possible with little to no need of oversight employees and competitive investment costs for blockchain development.
Since DeFi runs on blockchain technology, it requires more computation power than many other systems at times. With that being said, this requirement is often on par with conventional banking solutions that are utilized in many traditional settings. That is why, when you learn about what is decentralized finance and how it works, you can see an array of institutions utilizing it in the real world.
This low-cost mechanism also benefits the end user just as much as the creators of the DeFi network. From buyers to lenders and every role in-between, everyone can see a difference in the costs that are involved in carrying out their required activity. This provides you with a significant advantage. At the same time, it also adds to the convenience that is brought through other advantages of blockchain technology.
Multiple Use Cases
As defined above, learning what is DeFi allows you to see its application across various walks of life. Some of the most popular use cases of this mechanism include lending, selling, asset management, and risk management. This especially holds true for digital assets, which work exceptionally well with the DeFi model.
This also makes way for DeFi to be integrated by various organizations and businesses. Some of them may introduce open-source public networks that are managed and sustained entirely by their user base. Whereas, others may launch networks that are essentially controlled by businesses, but which also give users access to the benefits of blockchain technology. This opens doors to an array of sub-sectors within the financial industry, where DeFi can prove its worth.
Depending upon your requirements, you can easily search for these solutions after learning what is decentralized finance. However, it is important that you look for networks that are reliable, cost-effective, and provide more benefits to you than their direct competitors. This ensures that you are able to make the most out of your decision to use DeFi for important transactions.
What Type of Assets Are Used in DeFi?
The most commonly used assets in DeFi are stablecoins. These are cryptocurrencies that have their value tied to an external asset such as the U.S. Dollar. As a result, you are able to carry out your long-term transactions without having to cover for rapid fluctuation in the value of conventional cryptocurrencies.
With that being said, it is important to remember that stablecoins are not the only type of asset that is utilized within decentralized finance. In fact, once you learn what is DeFi, you can also identify an array of cryptocurrency being used throughout such transactions. While these transactions are not exactly bad, they do carry a certain risk due to the high chances of fluctuation in the related asset.
But if you understand the related factors, you can even use cryptocurrencies with your DeFi transaction without any surprises. However, you need to keep an eye out for changes in value. For instance, if you are using your conventional cryptocurrency as collateral to take out a fiat currency loan, you may need to revise the collateral to keep in line with the amount you originally agreed upon. Otherwise, you may be subject to penalties.
Due to these reasons, it is incredibly important that you understand all aspects that are related to transactions performed through DeFi. Not paying attention to the fineprint can often cause you to pay excessive and avoidable costs for no good reason. It is also important that you use reliable DeFi networks that come with favorable features.
DeFi Can Be Used in Conjunction With Other Technologies
Learning about what is decentralized finance can give you the required answers that explain the underlying blockchain technology. But it is also crucial to know that not all DeFi networks wholly depend on blockchain for their operations. Many of these solutions also use other technologies to create an interconnected network or ecosystem of their networks.
But in order to achieve and retain their DeFi status, these ecosystems still have blockchain technology set as their foundation. This means that even though technologies such as mobile apps and front-end software might connect different parties to each other, financial transactions and smart contracts will still use blockchain to execute the actual transfer of assets.
This way, these networks overcome the hurdles that many common users of the internet may have with accessing blockchain systems. At the same time, they still utilize the power of blockchain technology to maintain transparency, reliability, and cost-effectiveness.
The structure of these networks may cast a shadow on their existence as DeFi. But since they use the blockchain technology to maintain a public and decentralized ledger, they retain the description of being a DeFi.
How Can I Use DeFi?
Depending upon your requirements, you can use DeFi to fulfill a number of needs. This gives you extensive flexibility to utilize the technology to your advantage.
Using a DeFi platform does not require you to learn coding. As mentioned above, many DeFi networks make it a point to ensure easy accessibility to their solutions. This allows you to reach out to these platforms through the internet and utilize them via their website or mobile apps.
Since many of these platforms use blockchain technology, they develop their apps on the same solutions. This gives way to decentralized apps (DApps), which use the power of blockchain but remain quite easy to use.
With that being said, many DeFi networks require you to have a cryptocurrency wallet or exchange account. You also need to possess the knowledge to buy and transfer cryptocurrency. In many cases, converting your fiat currency funds to cryptocurrency is also required.
When you are learning what is DeFi and how it works, all of these requirements may seem like a lot to take on. But some of the most reliable DeFi solutions not only provide you with a variety of guides to carry out these activities, but also make it easier with the use of specialized tools.
The availability of user-friendly cryptocurrency exchanges and digital wallet applications also contribute to this ease of use. If you have a certain degree of computer skills, learning the ropes isn’t an impossible feat to achieve.
What Are Some Examples of DeFi?
There are a number of platforms that serve as an excellent example of what is DeFi and how it works. By looking at the top DeFi tokens, you can get an idea of what to expect from the technology. With that being said, it is important that you do your research and only utilize platforms according to the latest information about them.
Uniswap is a cryptocurrency trading platform that also makes way for a number of DeFi use cases. The network supports over 200 integrations of related DeFi apps. This provides you with access to a number of financial opportunities.
Terra is a stablecoin platform that makes use of the smart contracts technology. It is available on multiple blockchains, namely Ethereum and Solana, which makes it more accessible. Its compatibility with DApps makes it a growing DeFi platform.
Avalanche is a decentralized ecosystem that offers full compatibility with Ethereum. This allows the platform to be compatible for decentralized asset transfer, lending, and derivatives trading among other use cases.
DeFi is Still in the Early Stages
Since DeFi is a growing network of different platforms, you have an array of applications and providers to browse through within this segment. As you explore your options, remember not to invest funds that you cannot afford to lose. Since the technology is new, it is better to move forward with caution. This makes sure that you are able to make the most out of smart financial decisions while also keeping yourself safe from undue harm.