In the 2020-2021 cryptocurrency resurgence, DeFi (Decentralized Finance) has been a critical driver. All in all, DeFi remains one of the opaquest parts of the crypto world to the outside world. People still don’t get how decentralized finance works and why it has become so popular in the crypto market.
Well, for years now, the cryptocurrency had been promising its users universally accessible payments no matter where they are in the world. That has been a hassle to achieve for years until DeFi happened. Essentially, decentralized finance has taken this wild dream and made it a reality.
Decentralized finance is promising to provide everyone with an open and global alternative to the financial services we have today. Here we are talking of trading, insurance, savings, loans and more. As long as you have an internet connection and smartphone, you will be ten steps closer to this top-notch accessibility.
That said, in this article, we will discuss what DeFi is and how it works. So go grab a cup of coffee and put on your favorite cryptocurrency t-shirt and let’s dig into just what is DeFi.
Further, we will cover what has fueled the rise of decentralized finance and how the future of this industry is looking. Let’s dive in!
What is DeFi?
We can’t say that the use of technology in financial services is new. Even today, we accomplish most of the transactions in financial institutions with the help of technology. However, today, technology is only a facilitator in the transactions. That means the financial institutions are still the leading contenders here. They are still in charge of navigating the different standards for completing a transaction.
However, with DeFi, things will be different as it aims at placing technology at the front and centre of these transactions in the finance industry. In the simplest terms, decentralized finance is a concept where all the financial products are available on a decentralized public network. Therefore, these products are available to everyone to use instead of going through middlemen like brokerages and banks.
DeFi operates on software written on the blockchain that facilitates peer to peer interactions between the buyers and sellers, lenders and borrowers. At the same time, decentralized finance allows users to interact strictly with a software-based intermediary rather than relying on a company to facilitate their transaction.
The key takeaway here is that DeFi aims to use technology to remove the middlemen between parties in a transaction. Decentralized Finance will disintermediate the centralized models and enable the provision of mainstream financial services anywhere. Decentralized finance is like the link between traditional banking systems and blockchain technologies.
How Does it Work?
For Decentralized Finance to work, it needs to run on a decentralized infrastructure. And that is where Ethereum comes into play. DeFi revolves around decentralized applications that help to perform these financial functions on the digital ledgers; blockchains.
When it comes to DeFi, instead of the transactions happening through the centralized intermediaries, such as banks, the transactions occur directly between the two parties. All in all, smart contracts mediate these programs. The best part about this is that the Dapps can connect and form a more complex financial services structure.
As of current, most decentralized finance protocols are operating solely on the Ethereum blockchain. However, some have migrated to the competing blockchains in the search for better scalability and speed.
What are the Factors Influencing the Rise of DeFi?
Just like most traditional cryptocurrencies, DeFi is promising to rid of the intermediaries and go-betweens in transactions. This libertarian view coupled with the investors’ desires to make money from this incredible development has fueled the popularity of decentralized finance in the market.
While Bitcoin tried to fulfil this, there have been many limitations. Bitcoin has fallen short as it has protocols run by smart contracts to eliminate the possibility of foul play. But with DeFi, the possibility of creating a trustless and decentralized financial network is there.
Decentralized finance operates as an open financial network, and this openness is attracting many investors across the world. The value of tokens locked in the Defi platforms is now just over $43.35 billion and increasing by the day.
What are the Benefits of DeFi?
1. They are permissionless
The traditional bureaucratic banks are expensive, and it could take too long for transactions to process. The good thing is that DeFi came to solve these problems by opening everyone to the financial system irrespective of their geographic region, race, income or ethnicity. That means, for instance, you could take a Maker loan without worrying about your credit score or I.D.
2. DeFi Gives You Complete Financial Control
Decentralized finance platforms give you ultimate control over your finances. Once you have deposited your funds into decentralized finance platforms, you have maximum control on what happens to them. You don’t have to trust human intermediaries to decide how you manage your investments. Smart contracts do that instead, and no one can ban you from DeFi protocols as the smart contract law is not selective.
3. DeFi Gives You High Levels of Transparency
With DeFi, you get to enjoy a greater level of accessibility and openness. Decentralized finance protocols are built on a public ledger, which means all activities are available to the public. While everyone can view these transactions, they are not directly tied to anyone like traditional banks. The accounts on DeFi protocols remain pseudo-anonymous as the blockchain list the numerical addresses only.
4. Higher Interest Rates for the Investors
Besides Defi allowing you to keep your wealth, you can also earn income. Some platforms such as Compound and Aave will enable you to deposit your assets then lend them out to borrowers.
That allows you to earn interest of up to 5.73% for deposits on tokens compared to the average 0.7% offered by the traditional banks. It’s no doubt most people are now shifting their assets to the decentralized finance platforms.
In Summary; How’s the Future of DeFi Looking?
The performance of DeFi in 2020 shone more light on the cryptocurrency market. Now that in 2021 the locked assets on DeFi are increasing their value, traditional crypto companies are also looking to cashing into this hype. While decentralized finance is still facing similar growing pains as the crypto space, there is significant room for growth. Even with the handsome returns, everyone must beware that the crypto world is very volatile and can be risky for the average investor.