The term “decentralized finance,” or “Defi,” refers to the practice of managing financial transactions without a central authority or institution. Peer-to-peer partnerships can offer a broad range of financial services, from ordinary banking, loans, and mortgages to intricate contractual agreements and asset trading, which is how Defi plans to democratize finance by replacing old, centralized institutions. Visit multibank.io
To put it another way, Defi — short for decentralized finance — is a whole new concept of banking and financial services that are built around blockchain technology. Defi uses blockchain technology to provide “trust less” banking, eliminating the need for conventional financial intermediaries like banks or brokers.
What Are Investors Getting Out of It?
It is Defi’s goal to empower investors to “become the bank” by allowing them chances to lend money to each other and earn better returns than are available in regular bank accounts. As an added convenience, digital wallets allow investors to send and receive money instantly from across the globe, all without having to pay the high costs associated with conventional banking.
In this article, we’ll go over how Defi works, what it can do for people, and how it undermines conventional banking!
Here’s a Breakdown of How DeFi Works
Financial services like as loans, interest on deposits, and payments are all already offered by DeFi, but these services will be provided via decentralised technology. DeFi, on the other hand, alters the industry by altering the how rather than the what. A new financial infrastructure is being built to supply the same goods and services as DeFi.
To do this, it makes use of a variety of mechanisms, including blockchain and smart contracts. As a kind of decentralised public ledger, a blockchain keeps track of all financial transactions. Think about it as a chronologically ordered log of all transactions on that blockchain. People’s transactions are recorded in a ledger if one person pays another.
“Smart contracts, which are executable scripts that may hold cryptocurrencies and interact with the blockchain according to its laws, are the building blocks of DeFi,” explains Oleksandr Lutskevych, CEO and creator of CEX.IO, a service that enables DeFi and cryptocurrency exchange transactions.
As part of DeFi, participants’ transactions are executed automatically through smart contracts. When the terms of the contract are met, they automatically carry out the instructions they were given.
In peer-to-peer transactions, “DeFi enables smart contracts on the blockchain to take the role of trusted middlemen, such as banks or brokerage companies,” explains YieldFarming.com CEO David Malka. Everything from payments, investments, loans, and more may be done using DeFi’s peer-to-peer transactions.
In this scenario, Bitcoin is the primary means of payment and record-keeping for all transactions. It’s an exciting moment in the business since DeFi is the obvious extension of the Bitcoin white paper’s ambition of producing electronic currency.
Advantages Of Defi
- DeFi is open and welcoming to everyone – All you need is a cryptocurrency wallet and an internet connection to use DeFi services. There is no need to wait for bank transfers or pay bank fees to execute deals and shift assets around. Even if there may be additional expenses, such as petrol fees, for cryptocurrency transactions.
- There is no lag time between transactions – Every time a transaction is completed, the underlying blockchain is updated, and interest rates are changed several times each minute.
- Transactions are open and honest – Ethereum stock transactions, which account for over 90% of all DeFi traffic, are made public and validated by other members of the blockchain. Transparency of transaction data at this level guarantees that network activity may be seen by any user.
- Retain custody – non-custodial crypto wallets and smart contract-based escrow may be used to keep users’ funds safe.
- Tameable – Smart contracts may be programmed to execute automatically depending on an endless number of factors and are extremely customizable.
- Versatile – The usage of blockchain architecture ensures the integrity, security, and auditability of DeFi data.
- Open source – There are several DeFi protocols that are freely available online. The code for Ethereum and other open-source projects may be seen, audited, and expanded on by anybody. Open-source DeFi apps may be simply integrated to build new financial goods and services without the need for authorization from developers.
Risks To Consider
- Immature – The DeFi technology is still in its infancy and has not been thoroughly tested over a prolonged length of time. Funds may be misplaced or put in jeopardy. The Compound platform, for example, had a major error lately that resulted in consumers being handed millions of dollars in cryptocurrency by mistake.
- Protection issues – Consumers aren’t adequately protected. DeFi has prospered in the lack of restrictions and norms. As a result, they’re at risk when anything goes wrong. DeFi is not covered by any state-run reimbursement programmes, and there are no rules requiring service providers of DeFi to maintain capital reserves.
- Threats from hackers exist – DeFi’s extensive technical architecture, with several points of possible failure, enhances the so-called attack surface accessible to skilled hackers even if hacking is already a concern in conventional banking. In August 2021, “white hat” hackers stole $610 million from the DeFi platform PolyNetwork by exploiting a smart contract vulnerability. Fortunately, all the money was refunded.
- There is a lot of collateral needed- Almost all DeFi lending transactions need collateral of at least 100% of the loan amount, if not more, to be put up. Many forms of DeFi loans cannot be obtained if you meet these stringent criteria.
- The use of a private key is necessary – For DeFi and cryptocurrency, the wallets used to hold bitcoin assets must be safe and sound. Individual private investors and institutions utilising multi-signature wallets must meet this criterion. There are lengthy codes known only to the wallet’s owners called “private keys” that enable this. For example, a private investor who misplaces their key will be unable to access their money again.
How Does DeFi Undermine the Banking Industry?
Proponents of DeFi make the bold assertion that their revolutionary financial technology will upend the status quo. They claim that in the worst-case scenario, DeFi will eliminate the intermediary in financial transactions and be replaced by peer-to-peer networks.
Banks would be foolish not to provide DeFi if it is so effective. YieldFarming.com’s Malka believes that conventional financial institutions are increasingly turning to blockchain and distributed ledger technologies for their business operations. It’s just a matter of time until conventional financial institutions realise the inherent security of blockchain technology.
DeFi solutions will be developed by banks to “remain competitive and relevant,” says Malka. As he explains, “one might readily picture a situation where a typical bank provides its customers with yield-farming prospects.” According to CEX.IO’s Lutskevych, making such a shift would be simpler on paper than it would be in reality because of the regulatory load.
There are numerous well-established procedures that need to be rethought and risked while using blockchain technology, according to him. “More importantly, if these institutions were subject to regulation, authorities would have to approve their operations.”
Conclusion
Those wishing to get started in DeFi, beyond the fundamentals of cryptocurrency trading, should approach with caution and make certain that they are working with a reputable counterparty to avoid being scammed.
Even though the returns given by DeFi are attractive, don’t allow the prospect of a high return blind you to the hazards involved. In the cryptocurrency markets, a downdraft may swiftly wipe out any minor profits made by yield farming, and blatant frauds or theft might wipe out your whole cryptocurrency portfolio even more quickly.