Defining (Defi) Decentralized Finance Based on Crypto-2023
January 7, 2023
5 min read
Do you remember how Initial Coin Offerings were all the rage in 2017? Well, that's about the same thing happening with Defi right now. Decentralized finance is a big moment as it's an emerging field gaining popularity as an alternative to traditional financial services.
It's an experimental niche within the wider crypto space that lets users cut out intermediaries, enabling users to conduct complex financial transactions directly with each other. In recent years, Defi has been gaining the attention of mainstream media as it sets its path to disrupt the traditional banking and financial sector.
Defi is here to replace the legacy centralized institutions with a decentralized peer-to-peer financial system that can provide investors with a full spectrum of financial services. With that said, this article will discuss everything you'd like to know about Defi and how this new financial system could change the world.
What is Decentralized Finance?
Defi is a new idea in banking and finance facilitated by blockchain technology that relies on peer-to-peer transactions. It uses blockchain to enable trustless banking, casting aside traditional financial institutions like banks and brokers.
Why should investors care? By giving investors a chance to lend money in a non-custodial manner and earn higher yields than those offered in conventional banking, Defi aims to help investors themselves become the bank.
Investors can send money quickly and easily to any location in the world. On top of that, investors' money is accessible through digital wallets without paying traditional banking fees. In essence, Defi services intend to be cheaper, faster, and more straightforward, among other advantages that will come with further development of this technology.
Although participants may not interact in a straightforward manner using Defi products, third parties are replaced with technology, so there's no centralized intermediary overseeing the transactions.
How Does Defi Work?
Today, nearly all facets of finance-banking, lending, and trading are now controlled by central governing authorities. That pushes regular consumers to deal with various financial intermediaries to access everything from mortgages, auto loans, and insurance to trading stocks and bonds.
As a result, that limits the direct access points consumers have to capital and financial services. That means consumers cannot avoid intermediaries like banks, lenders, and exchanges who are dead set to take cuts from each financial and banking transaction.
Defi shakes up such traditional financial systems by eliminating middlemen and empowering ordinary people through peer-to-peer exchanges. In essence, it borrows some of the critical elements of the work banks, insurers, and exchanges have done and puts them in the hands of everyday people.
The use of such technology in the financial sector is not a new concept. Even today, most of the transactions completed by financial institutions are enabled by computer code. But you will quickly notice that in a centralized financial system, technology is only a facilitator. The financial systems are still the leading contenders.
But with Defi, a distributed database collects and aggregates data from all users and uses a consensus mechanism to verify it, making it accessible from different locations. In essence, Defi protocols give individuals involved more control over their finances through individual-focused trading services and personal wallets.
Types of Defi Applications- How is Defi Being Used?
Defi is becoming more prevalent in both straightforward and intricate financial transactions. That said, it's being used in the following ways;
Traditional Financial Applications
Decentralized finance is used in trading securities, and other aspects of finance such as insurance, lending, borrowing, and payments.
. Flash Loans
Flash loans are the other popular application of decentralized finance. They allow you to borrow money and repay the loan instantly without any upfront collateral, as the borrowed funds are paid back in seconds within the same transaction on the blockchain network.
Decentralized finance technology has made it possible for developers to create digital wallets which function independently from centralized exchanges. These wallets give users access to multiple financial products, including digital assets and blockchain-based games.
· Yield Harvesting
Defi also enables speculative investors to lend their cryptocurrencies with the potential to make significant profits. In essence, Defi borrowing platforms pay lenders proprietary coins for accepting loans, and these coins could appreciate over time.
Non-Fungible Tokens turn non-tradable assets, such as the very first tweet on Twitter, into digital assets. In short, NFTs make commodities out of things that weren't before.
Since cryptocurrencies are notoriously volatile, stablecoins link their values to other currencies that are not cryptocurrencies, such as the U.S. dollar, to stabilize their prices.
· Decentralized Exchanges
Decentralized exchanges (dexs) are a peer-to-peer marketplace that allows financial transactions to occur directly between cryptocurrency traders. Unlike traditional centralized exchanges, there's no central authority. Crypto traders have complete control and ownership of their funds. There's no involvement of brokers, banks, payment processors, or any other intermediary.
What are the Benefits of Decentralized Finance?
No matter what you want to achieve, working with a Defi platform rather than a traditional financial institution can have several advantages. Here are the significant benefits;
Unlike conventional financial systems that limit some people from opening bank accounts and receiving loans, anyone with an internet connection can access Defi platforms. With such a high level of accessibility, Defi transactions could take place just about anywhere in the world.
Ii. Increased Transparency and Security
Most of the communication on Defi platforms is sent through the Ethereum blockchain. There's so much data visibility that every individual has access to the network activities.
In essence, smart contracts and transactional records are available to everyone while protecting the privacy of individual participants. On top of that, the records are immutable, meaning they cannot be changed.
Iii. Low Fees and Interest Rates
Thanks, to Defi, peer-to-peer payments can occur between any two parties. Without a middleman, transaction costs are significantly lowered, and parties involved can directly negotiate interest rates. Defi applications typically offer much higher interest rates to borrowers than conventional financial systems.
Iv. Functional Autonomy
The 2008 financial collapse clarified the risks associated with centralized systems and highlighted the significant interconnectedness of most banks and governments. Therefore, Defi platforms don't use any centralized financial institutions.
In most cases, centralized institutions are exposed to fraud and corruption or may become overly leveraged and go bankrupt. But with the decentralized structure of Defi protocols, the risk is significantly reduced.
v. More Control
Since the Defi protocol is transparent, permission less, and decentralized, crypto traders have more control over their finances.
The system's flexibility also makes it simpler to create protocols and decentralized apps (DApps) that complement one another at a deeper level than is possible in the world of traditional finance.
While we have learned an expensive lesson this last year, events like this continue to highlight the many tradeoffs users have to make when they choose centralized financial institutions. And with that said, this section will highlight some of the Defi trends we should watch closely in 2023.
1. Yield Farming
This is the most recent addition to decentralized finance, also known as liquidity mining. It allows participants to earn crypto with their crypto. Instead of leaving your crypto assets in cold storage, you can put them to work and generate more value.
With yield farming, crypto that would otherwise sit in your wallets or centralized exchange platform is lent out via different Defi systems or locked into smart contracts giving you returns. The rewards can include fees, service charges, or digital money.
Staking is a reward-driven process in which individuals hold/lock up their crypto holdings on a decentralized exchange to receive rewards and earn interest. It is an additional opportunity to profit from your cryptocurrency holdings on the Defi platforms.
3. Greater Adoption of Stablecoins
Stablecoins are a unique type of token on the Defi platform. They are created solely to stabilize the market value of cryptocurrencies by providing a consistent market price. And as a result, they overcome market volatility and provide a secure trading experience for Defi platform users.
4. Governance Tokens
Governance tokens are also being developed as part of Defi projects. These tokens serve different functions and are unrelated to traditional cryptocurrencies. The primary purpose of these governance tokens is to provide voting power to Defi system users.
5. Cross-chain Technologies
One of the most recent applications of the Defi movement is cross-chain technology. For better information exchange, it enhances interoperability between two separate blockchain networks.
For instance, Matic is an excellent illustration of cross-chain technology. It provides a remedy for slow transactions and constrained scalability by speeding up transactions and enhancing user experience.
6. Defi Gaming
As the number of gamers grows, the blockchain gaming sector is experiencing massive Defi growth. Blockchain gaming allows players to mine cryptocurrency, NFTs, and other intangible assets while playing. Further, Defi protocols help secure the in-game transferability of assets, making it easier to commercialize the gaming industry.
7. NFT Platforms
Since content producers, retailers, and service providers have started frequenting NFT markets like Opensea and Mintable, non-fungible tokens have paved the way for the growth of the new digital economy.
Besides art and digital artefacts, NFTs have other blockchain applications. For instance, when musicians tokenize their songs and sell them directly to their fans. On top of that, NFTs make it easy to automate payments to record labels, musicians, managers, and other parties.
Metaverse will foster a new immersive fan economy powered by social tokens. It has the potential to revolutionize the monetization of digital assets. For instance, communities or celebrities can monetize their brands using social tokens.
What's more, Metaverse fosters bidirectional relationships between artists and customers to benefit both parties. That makes individuals instead of organizations the creative agents in a distributed collaborative paradigm.
9. Blockchain Development
Digital transactions are becoming more efficient thanks to blockchain technology's improved transparency and security, which is supported by decentralization. Ethereum, a well-known blockchain network known for simplifying/improving data security in international payments, digital currency, fintech applications, and smart contracts, is used in Defi to achieve this.
Frequently Asked Questions
Q: What are some ways you can make money with decentralized apps?
A: The most straightforward way to earn income with Defi is to deposit your cryptocurrency on a platform or protocol that will pay you an APY (annual percentage yield).
Q: Is Defi safe?
A: It's crucial to proceed with caution when making the decision to invest in Defi, as with all financial choices. Most financial experts classify Defi as speculative and advise only investing 3-5% of your net worth in such cryptocurrency assets. All in all, Defi provides many advantages since there is no central authority.
Q: How Will Ethereum 2.0 Impact Defi?
A: The current Ethereum network makes it too expensive to execute smart contracts and other transactions required for the Defi market. Ethereum 2.0 is expected to lower the transaction fee and simplify the execution of smart contracts required for Defi applications.
Q: What are the challenges of Defi protocols?
A: Lack of regulatory compliance, hacking and threat vulnerabilities, scalability issues, performance issues, smart contract restrictions, high transaction costs, and limited liquidity pools.
Q: Can decentralized exchanges replace centralized financial institutions?
A: Many believe that various projects on Defi platforms have the potential to become the next Robinhood, attracting new users by enhancing the accessibility and inclusiveness of financial applications to those who would not typically have access to them.
CEO, Benco Services
I have been heavily involved in social media development, growth, marketing strategy and community management of culture related channels for 2 years, working on and owning numerous social pages with hundreds of thousands of members/followers. I then moved to more project management and business management positions within the projects I operated in.