What Is Decentralised Finance (DeFi)
To understand this topic; What Is Decentralised Finance (DeFi) very well, we shall discuss the following sub-topics
– The benefits of Decentralised Finance
– How can Decentralised Finance help the financial services sector?
What Is Decentralised Finance (DeFi)?
The term DeFi, short for decentralized finance, is used to describe various blockchain-powered applications aimed at creating peer-to-peer alternatives to traditional financial services and institutions.
Having generated a lot of excitement last year, decentralized finance has kept powering ahead, attracting impressive amounts of capital and meeting expectations that it would be among the leading trends of 2022.
According to DeFi Pulse, the go-to data aggregator for decentralized finance, the total value locked in DeFi protocols currently stands at just under $11.5 billion, up from less than $1 billion a year ago. While this certainly pales compared to traditional financial markets, the key takeaway is that DeFi has grown more than tenfold over the past 12 months.
This is a clear sign of decentralized finance’s surging popularity. Most encouraging is that rapid growth seems to reflect the strength of DeFi’s value proposition. Let’s examine what makes decentralized finance such an investment draw.
The benefits of Decentralised Finance
The DeFi movement promises many benefits to customers and investors, including eliminating intermediaries and central oversight, making financial markets more accessible to retail investors, and creating new investment opportunities. To achieve their lofty ambitions, DeFi developers are using some fundamental properties of blockchain technology.
The term ‘decentralized finance’ is already a clear indication of what the DeFi movement considers to be its defining feature. That’s hardly surprising. Decentralization is at the heart of blockchain’s value proposition. The aim is to avoid relying on corporations and other institutions for oversight, server space, data storage, and so on. Blockchain networks achieve this by ensuring that one transaction history is shared among all members.
The decentralized approach can help democratize banking and finance by ensuring everyone has easy access to financial services.
Most DeFi apps run on Ethereum, the second-largest blockchain protocol after Bitcoin. As a permissionless (public) blockchain, Ethereum is highly decentralized and readily accessible to anyone interested in building or using a DeFi app. In addition, the permissionless nature of the blockchain and the interoperability it enables open the door for all kinds of third-party integrations.
It is important to note that these features are not exclusive to Ethereum. However, being the leading network for smart contract development has positioned Ethereum as the preferred platform for building not only DeFi applications but also other types of decentralized apps (dApps).
With decentralization also comes greater transparency. Since the distributed ledger containing information about all the activities that have taken place on a blockchain network is shared by everyone, the network’s data is publicly available for inspection. Furthermore, the blockchain’s cryptographic principles guarantee that information is recorded only after its authenticity has been verified.
For customers, the transparency afforded by DeFi applications can be a game-changer. It can improve due diligence and help people identify and avoid potential financial scams and harmful business practices.
Blockchain technology achieves true immutability through the clever use of cryptography and consensus algorithms like proof-of-work. This guarantees that manipulating records stored on a blockchain network is practically impossible. Combined with the features we already discussed, this creates a level of security that’s difficult, if even possible, to achieve with traditional means.
DeFi apps bring blockchain’s inherent advantages to the financial sector while also striving to create convenient interfaces to ensure a smooth user experience, in addition, employing smart contracts such as dApps provide extra protection against bad actors and fraudulent transactions.
How can DeFi help the financial services sector?
From what we’ve seen so far, DeFi certainly has the potential to benefit traditional finance. But as with any transformative technology, DeFi’s potential is not limited to just improving on the current status quo. Instead, its true strength lies in its ability to disrupt the space by enabling new types of financial products and services. Even at this early stage, the technology is showing great promise. It is already changing how people manage their assets, borrow and lend money, and trade online. Here are just some of DeFi’s most prominent use cases:
Lending and borrowing
DeFi has enabled the development of peer-to-peer lending and borrowing solutions that significantly benefit the end-user. These services come with cryptographic verification mechanisms and smart contract integration that eliminate intermediaries such as banks that typically verify and process lending and borrowing transactions. This makes the process much cheaper and faster while ensuring that the counterparties involved in a transaction are protected. Other benefits include instant settlement of transactions and greater accessibility.
Lending and borrowing dApps are among the most popular DeFi applications. One platform that has become particularly popular in this category is Compound. Lenders on the platform can supply crypto assets to several lending pools available for others to borrow from. These lenders are entitled to a share of the interest borrowers pay back to the pool. The interest rate a lender earns is based on their contribution to the pool, as well as the liquidity of the crypto assets.
The growing popularity of DeFi lending platforms has opened up new ways for people to manage their savings. As mentioned above, users start earning interest on those assets by locking their crypto assets into lending protocols such as Compound. This has led to the emergence of DeFi saving apps that can plug into different lending protocols to maximize users’ ability to earn interest. The term ‘yield farming’ has been introduced to describe the increasingly popular practice of users moving their idle crypto assets around in different lending protocols to get higher returns.
The Ethereum boom from a few years ago led to the emergence of one of blockchain’s most important trends – tokenization. The protocol’s robust smart contract capabilities enabled the issuance of crypto tokens – digital assets that exist on a blockchain and can have various properties and uses. These range from utility tokens native to a specific dApp, security tokens that can be likened to digital shares, real estate tokens enabling fractional ownership over physical properties, and more.
Tokens can also provide exposure to physical and digital assets such as oil, gold, fiat currencies, and cryptocurrencies. These so-called crypto synthetic assets are collateralized by tokens locked into Ethereum-based smart contracts. For example, one of the most popular synthetic asset platforms, Synthetix, currently has almost $600 million locked in smart contracts.
Closely related to crypto synthetic assets, stablecoins are crypto tokens pegged to a stable asset or basket of assets. In most cases, stablecoins are pegged to fiat currencies like the US dollar, but there can also be commodity-pegged and cryptocurrency-pegged tokens. Stablecoins aim to reduce the price volatility of cryptocurrencies and strengthen the case for using blockchains as payment solutions.
We can identify three types of stablecoins based on the method used to maintain their value. Collateralized stablecoins require the coin issuer to hold the assets against which their coin is pegged (fiat currency, gold, silver, etc.). Other coins are pegged to cryptocurrencies, and their value is maintained by over-collateralization and stability mechanisms. Finally, there are also non-collateralized tokens whose prices are kept at fixed levels algorithmically.
Stablecoins are, in many ways, what fuels the DeFi engine. They’re widely used across the space to enable remittance, lending and borrowing, and other DeFi services.
DeFi is also starting to impact how we change online goods and services. An illustration of this is the recent emergence of decentralized exchanges( DEXes), which grease peer-to-peer trading of digital means. Uniswap is one of the major players in this order.
Am so sure if you are asked; What Is Decentralised Finance (DeFi) you shall be able to explain well.
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Given DeFi’s stellar growth in 2022, it’s hard not to feel optimistic about the future of the space. The new year will probably bring new challenges, but with interest in DeFi rising, fresh opportunities will also arise.