DeFi is a new form of financial technology that makes use of decentralized ledgers, similar to those employed by digital currencies.
In the United States, the Federal Reserve and Securities and Exchange Commission (SEC) establish the regulations for centralized financial organizations such as banks and brokerages, which customers use to gain access to capital and financial services directly. DeFi undermines this centralized monetary system by providing individuals with peer-to-peer digital transactions.
DeFi removes the fees that traditional financial institutions demand for their services. People can store money in a safe digital wallet, make transfers quickly, and anyone with an internet link can access DeFi.
Centralized Finance vs. Decentralized Finance (DeFi)
Decentralized finance is unlike traditional financial systems and banking that are centralized.
Centralized Finance
In centralized finance, financial institutions and third parties are responsible for transferring money between parties, with each one charging a fee. When a credit card payment is made by the merchant, it’s sent to an acquiring bank which passes on the card details to the credit card network.
The network processes the payment and requests reimbursement from the bank. Each entity in this process receives compensation for their services, as merchants have to pay to use debit and credit cards.
Centralized finance oversees all types of financial transactions, from taking out loans to using a local bank’s services.
Decentralized Finance
DeFi eliminates the need for intermediaries and enables people, merchants, and enterprises to perform financial operations through modern technology. Peer-to-peer networks use security protocols, connections, software, and hardware upgrades to make this possible.
Wherever there is an internet connection available, users are able to lend money, trade assets or borrow funds using applications that store and authenticate financial activities in distributed finance databases. These databases are accessible from multiple locations as they collect information from all users and use a consensus system to validate it.
Decentralized finance eliminates the need for a centralized financial system, allowing users to access financial services anywhere regardless of their location or identity. Through personal wallets and tailored trading services, DeFi applications give users more autonomy over their finances.
How Does DeFi Work?
Decentralized finance harnesses the same blockchain technology that is used by cryptocurrencies. This type of database or ledger is distributed and secured. The transactions are managed through programs known as dApps, which also run the blockchain.
The blockchain works by recording transactions in blocks that are then checked by other users. If the verifiers validate the transaction, the block is secured and encrypted; a new block is generated that contains details of the prior block.
Each block in a blockchain is connected to the next one by the information it contains, thus conferring its name. The data stored in earlier blocks cannot be altered without affecting subsequent blocks, making it impossible to tamper with a blockchain. This concept and other safety measures are what make blockchains secure.
The applications of DeFi
Peer-to-peer (P2P) financial transactions are a principal concept of DeFi. When two people decide to swap cryptocurrency for products or services without a third party being involved, it is considered to be a P2P DeFi transaction.
In DeFi, an algorithm pairs individuals who have similar conditions for the loan and then the loan is issued. Funds are sent through decentralized applications (dApps) in the blockchain following the same process. Adopting DeFi allows for:
- Accessibility: Anyone with an internet connection can access a DeFi platform and transactions occur without any geographic restriction.
- Low fees and high-interest rates: DeFi enables any two parties to directly negotiate interest rates and lend money via DeFi networks.
- Security and Transparency: Smart contracts published on a blockchain and records of completed transactions are available for anyone to review but do not reveal your identity. Blockchains are immutable, meaning they cannot be changed.
- Autonomy: DeFi platforms don’t rely on any centralized financial institutions and are not subject to adversity or bankruptcy. The decentralized nature of DeFi protocols mitigates much of this risk.
Pros & Cons of DeFi
| Pros | Cons |
| Decentralized applications allow individuals to transfer capital around the world | Participation in DeFi is complex and not easily understood |
| Investor’s ability to generate income | High risk of fraud and scams |
| High level of security | High level of volatility |
The Prospects of DeFi
Decentralized finance is continually progressing. It has no official oversight, and its environment is filled with infrastructure issues, thefts, and fraudulent activities.
Regulations which are currently in place were formulated on the concept of distinct economic jurisdictions, each with its own set of laws and regulations. The capacity of DeFi to facilitate cross-border transactions poses key questions for this type of control.
Which agency or agencies are tasked with looking into a financial crime that has occurred between different countries, protocols, and decentralized finance applications? How will they enforce the relevant rules and laws?
Other issues to consider are the reliability of the system, energy needs, environmental impact, modifying the system, keeping the system up-to-date, and possible hardware malfunctions.
What Does DeFi Do?
DeFi seeks to undermine the reliance on centralized financial institutions and third parties that are necessary for all financial transactions.
Is Bitcoin a Decentralized Finance?
Bitcoin is a form of cryptocurrency and is not the same as DeFi, although it plays an integral role in the DeFi ecosystem.
What Is Total Value Locked in DeFi?
The total amount of cryptocurrency locked up for use in DeFi activities is known as Total Value Locked (TVL). This includes all cryptocurrencies that are used for staking, lending, depositing into a pool, or any other financial transaction. Additionally, it can also refer to the sum of certain individual cryptocurrencies such as Ether or Bitcoin which are utilized for financial purposes.
In conclusion
DeFi is a new type of financial technology that stands in opposition to the traditional banking system. It does away with the charges imposed by banks and other monetary institutions for their services, instead encouraging peer-to-peer exchanges.
