Beginner’s Guide: DeFi
A key part of cryptocurrency’s mantra is to make money and payments accessible for anyone, anywhere. That mantra became more evident through the birth of DeFi as it became one of the most accessible opportunities for conducting financial services anywhere in the world.
DeFi is one of those buzz terms that found its way into the world of crypto in 2020; not only did it become a buzzword in the coin community but also became the best performing digital asset for that year and since then crypto enthusiasts have been interested in learning the dynamics of DeFi.
What is DeFi?
To put it simply, DeFi or Decentralized Finance is a financial service that defines how cryptocurrencies can act as smart contracts for building exchanges, insurance services and lending services without centralized authorities.
The idea behind DeFi is to remove the need for a centralized entity. It means users can now have full control over their assets as they interact with the ecosystem without obstacles. This simple advantage is what makes DeFi a relevant asset in the crypto world; however, more than that simple fact, there is more to the “DeFi gem.” This article will go over its advantages, limitations, promises, and potential applications.
DeFi vs Open Banking
When you think about open banking, you imagine a banking system with third parties involved. These third parties have secure access to financial data through APIs, which allows account and data networking. It is simply a traditional financial system but an opportunity to explore new products and services.
On the other hand, DeFi is an innovative financial system independent of existing infrastructure.
It’s just like having a bank and open banking given control over the management of traditional financial instruments by drawing data from several banks and institutions securely. However, DeFi manages a unique financial infrastructure with new deployment methods and systems.
Advantages of DeFi
The DeFi movement contributes so much to consumers and investors as it keeps improving accessibility to financial markets and eliminates centralized control and intermediaries. More advantages of DeFi are:
Eliminates Intermediaries and Arbitration — Traditional finance have to depend on banks as intermediaries to thrive, but with DeFi, there is no longer a need for arbitrators or intermediaries. Users now have control over what goes on with their funds and resolution clauses in disputes, which reduces the cost associated with using the platform and improves the total user experience.
Permission-less and Accessible — DeFi also makes it easy for users to conduct financial services without reply on traditional systems. This is significantly advantageous for low-income individuals because they can access a wide range of financial services at a reduced cost.
Security and Less Complicated — DeFi can be deployed on blockchains which means a single node that is now duplicated across thousands of nodes, which makes it easy to build but difficult to hack.
Lending — the crypto world is becoming attractive to many people, even borrowers. They can now use their funds as collateral without worrying about their credit score.
A Healthier System — especially after the global economic crisis, DeFi has proven that we need decentralised financial systems to reduce contact and allow access to funds.
Limitations of DeFi
As much as we see the good DeFi is capable of, it is still difficult to sideline some of the limitations and challenges that come with decentralized finance. Some of them are:
Uncertainty and Poor Performance — sometimes these blockchains can be slow, which makes the application unstable, posing several risks to the assets in the system.
High Risk of User Error — What DeFi has successfully done is to take the burden of intermediaries to users. This looks like a good thing but can also be a curse because it can be difficult to maintain and deploy the products since it is released in immutable blockchains.
Bad User Experience — Just like we said earlier, a majority of the responsibility now falls on the users, which can be dangerous at times.
Potential Applications of DeFi
Some of the exciting use cases of DeFi are;
Monetary Banking Services — DeFi are essentially built to make monetary services accessible for anyone, including insurance, mortgage, and coins insurance. Smart contracts created by DeFi make the cost of doing things like underwriting and legal fees reduce significantly. Blockchain insurance also means lesser premiums and the same quality service.
Decentralized Marketplaces — one of the most crucial parts of DeFi applications is decentralized exchanges. Why? These applications make it possible for users to trade digital assets without intermediaries, which means lesser trading fees and better exchanges. It can also issue ownership of conventional financial instruments and launch tokenized securities with custom parameters.
Some other potential use cases are synthetic assets, decentralized prediction markets, the creation of derivatives, and much more.
The Future of DeFi
DeFi is making such a dramatic rise in the world now and it will only get better.
The DeFi will expand into more blockchains. DeFi will become more interoperable such that for instance Bitcoin can be used on Ethereum as a wrapped BTC. DeFi will also interact with other blockchains until it takes over the place.
DeFi or Decentralized Finance like it is popularly called is all about building decentralized financial services that remove discrimination, centralization and insurgent control. However, as much as DeFi is selling a good idea, it is serving some people as much as they hoped because some systems will only function properly when there is control.
However, if the crypto world finds a way to make the system decentralized yet optimal enough to serve the needs of everyone, it will become an efficient mainstream adoption for many financial services.