The blockchain-powered space of Decentralized Finance does away with the need for an intermediary by creating a space for individuals and institutions to access financial applications widely and freely.
DeFi is an alternative to the age-old global financial system held together by stringent norms. It is a space that makes the financial system open to all, giving each one direct control of their money and transparency. The only criteria for DeFi services are to have a basic internet connection.
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DeFi is the term used for decentralized financial services that can be accessed by anyone with Ethereum and anyone with an internet connection.
DeFi is not regulated by a central authority that holds the right to deny or approve. Since it is completely automatic, the risks of human error are almost eliminated. The services are managed through codes that can be examined by anyone.
The innovation in DeFi is done by combining applications uniquely. The adoption of DeFi as a financial service depends on the usability of Ethereum.
Here are the DeFi basics that you absolutely need to know:
#1- A Financial System on the Internet
The DeFi is a financial system on the internet without being subjected to the rules and regulations of an intermediary. DeFi is governed and maintained by computers across the globe. What makes DeFi stand out is that it requires no permission to enter. It is open to all. DeFi allows users to remain anonymous through all transactions. In DeFi, people don’t have to run the risk of their funds being allocated to other areas. The funds need not be parted with since they are non-custodial.
#2- DeFi makes financial services more accessible
DeFi guarantees to take financial services from the conservative ways of lending, borrowing, exchange, and derivatives markets, to an all-new place that makes transactions quick, anonymous, and accessible, and affordable to all. With no regulatory body, financial services will be speedy and without any barriers along the way.
#3- DeFi is Censorship Resistant
Since DeFi is decentralized with no regulatory body authorized to monitor the financial services, it is resistant to any form of censorship.
The exemption from censorship is a factor that is becoming increasingly appealing to the masses. With many of the world’s largest tech and finance companies ridden with censorship, the people are looking for a change and an alternative. DeFi ensures a free and open platform for financial services.
#4- DeFi is yet to be a complete reality
While the development of DeFi is still under process, there are some barriers along the way. For one, Ethereum gas fees are an issue. Ethereum is essential in processing, executing, and settling requests for different services. Each time a transaction is made through the Ethereum network, a fee is to be paid. Due to too much activity, the network is burdened and the transaction cost is expensive. Ethereum is also unscalable, which poses quite a problem and is looking to be resolved through a more scalable Ethereum 2.0. Similarly, the lack of an intermediary may cause mistrust among those engaging in transactions.
#5- DeFi is mostly using the Ethereum blockchain
Most DeFi applications are using Ethereum as their default blockchain since it is most flexible with !)ST, a healthy developer base. Ethereum has dominated blockchains in terms of apps, app activity, volumes traded, and user activity. Other blockchains are currently not actively into DeFi due to a lack of complete decentralization, benefits, and most importantly a healthy developer base.
Decentralized Finance apps can be possible on Bitcoin but their programming would be significantly more complicated. Since Bitcoin ensures security which is necessary for decentralized exchange of financial services, a small DeFi network can be created on Bitcoin.
#6- DeFi is run by ETH and DAI
While we have already seen the Ethereum blockchain, its flexibility, decentralization, and developer base, it is important to note that it is Ether, an Ethereum native that is used for payment of blockchain transactions. Is also the easiest to convert Ether into other currencies as compared to other cryptocurrencies.
DAI, on the other hand, is a creation on Layer 2 of the Ethereum blockchain that offers the benefits of a stablecoin. A stablecoin is fully decentralized. It is also pegged to the USD that makes it much less volatile. DAI, with its ability to move through DeFi protocols with ease, has become one of the reasons behind its success.
#7- Ethereum as a blockchain could also create some hurdles
Despite Ethereum being the best possible blockchain for decentralized apps, there are a few hurdles that can come along the way. Ethereum, as a blockchain, is vulnerable to congestion due to heavy usage, leading to inefficient services and delays in transferring information and transactions. Since transactions take place in gas fees, those with lower fees are likely to remain pending for long.
Ethereum faces scalability issues due to its immense popularity in the blockchain network. Other blockchain networks may not face scalability issues due to larger centralization and higher speed. The drawbacks of Ethereum can be excused at this stage since it is still new and developing.
#8- Decentralized Finance involves smart contracts
A smart contract uses computer code to specify the terms of the relationship between two entities. The applications of Decentralized Finance include the creation and execution of smart contracts.
Since the terms are coded on the computer, they are also enforced through it. This supersedes the need for manual inspection and enforcement. Smart contracts build trust and reduce risks for both parties involved. But there is one kind of risk that smart contracts are prone to bugs and hacks.
#9- DeFi also has some drawbacks
- DeFi deals in cryptocurrencies. So, a prerequisite is to convert national currencies into cryptocurrencies. Moreover, the success of DeFi depends on innovation in unchartered territories. DeFi is still underdeveloped in terms of creating a good user experience.
- The financial industry necessitates the need for liquidity for effective pricing. But in terms of liquidity, DeFi is still slow.
- Since there’s a lack of credit scoring or shared collateral, products are often overcollateralized, which results in reduced opportunities for traders to access capital that the users don’t own.
- Blockchain transactions are irreversible even if they are done by way of fraudulence. Also, viruses, etc, are much harder to detect through the complex system.
Even having said that, there is no denial that the future of finance is going to be decentralized, faster, and unregulated. DeFi is set to connect the world’s financial services through blockchain.