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Introduction to Decentralised Finance (DeFi)

Introduction to Decentralised Finance (DeFi)

Imagine a world where you don’t get charged crazy fees by your bank when you send money to your loved ones abroad or one where you can negotiate the rate at which you borrow money.

You don’t have to daydream for long or even at all; it’s already here. DeFi makes that possible. 

The term Defi was coined in 2018 by a group of entrepreneurs and Ethereum developers who wanted to open up finance applications from traditional systems.

DeFi is focused on totally removing middlemen like banks and card merchants from the process of financial transactions. 

The new financial system allows you to lend, borrow, pay, donate and earn money in seconds without a bank account.  

It allows individuals to transact directly between themselves, without the need for a central authority or intermediary, thereby disrupting the banking industry and the entire traditional finance sector.

These direct transactions are called peer-to-peer transactions, which means directly between two individuals and are powered by cryptocurrency and blockchain technology.

With DeFi, you can send money to someone else anywhere in the world, and it’ll arrive in seconds. 

Just like with every other application of the blockchain, DeFi transactions are verified by a secure and transparent ledger system that inputs and records every transaction in connected chains of computer code. 

To fully understand decentralised finance, we must first talk about centralised finance and the systems which decentralised finance wants to replace. 

Centralised Finance

Centralised finance involves using secondary merchants like banks and other financial institutions to verify financial transactions. 

In centralised finance, you can only make financial transactions when your money is deposited in the central financial system via a bank or other financial institutions. 

When the central financial system facilitates transactions between two parties, each financial institution involved charges a fee for its services. 

Let’s say you buy groceries using your credit card. The charge goes from the merchant to a bank, and the bank then forwards the card details to the credit card network for approval. 

The network verifies the charge and requests a payment from your bank. Your bank approves the charge and sends the approval to the network, through the acquiring bank, back to the merchant. 

These transactions can take up any amount of time, from minutes to days, and all the entities involved in the system receive payment for its services in the form of transaction fees.

Decentralised Finance

Decentralised finance removes the need for all the extra intermediaries in a financial transaction. It helps people transact directly with each other using decentralised applications (DApps). 

Decentralised apps are applications built on the blockchain and operate with blockchain technology.

These apps allow you to perform financial transactions from anywhere globally as long as you have an internet connection.

The money is stored in personal DeFi wallets, which are hosted on the blockchain and can be accessed anywhere in the world. 

How does DeFi work?

As the technology matures, more people are discovering new ways to deploy DeFi technology and utilise it in different ways.

Currently, most DeFi transactions are carried out on the Ethereum blockchain. The Ethereum blockchain is popular for decentralised apps and smart contracts, the technologies which power DeFi. 

A smart contract is a group of computer code that has been written to automatically execute an action whenever a set of criteria is met. 

For example, if you put your money up to be used as a loan facility in a DeFi network, the money will be released once the borrower meets preset conditions; there is no need for you to actively be involved. 

And if you want to get a loan, you put up a loan request on your DApp and the algorithm pairs you with willing lenders who match the amount you want and the interest rate you’re willing to pay. There is no interference or human bias. 

Smart contracts are responsible for authorising borrowing, lending, and every other financial transaction in the DeFi network. 

The terms of the transaction are written in the code and cannot be changed without the creator’s knowledge.

How is DeFi being used? 

Since it is still emerging, more people are looking at ways in which the groundbreaking technology can be harnessed to make life easier. 

These are some of the things which DeFi is currently being used for:

Lending

You can put up your crypto as a loan facility. Other crypto users can borrow from it, and you can earn interest on it every minute. This is more than you can say for regular banks with meagre interest rates. Platforms like Aave help people give out their crypto assets as loans. 

Decentralised exchanges

You can use your DeFi crypto to facilitate direct crypto transactions. For example, you can directly exchange your BTC or ETH for another person’s cash without needing a central authority to approve the exchange. Uniswap is a popular decentralised exchange.

Getting a loan

See Also

Get a loan instantly without filling out any forms and in a much faster time than your regular bank can ever deliver. Compound allows crypto users to borrow money for other uses. 

Trading

Make peer-to-peer trades of certain crypto assets — Think of it as buying and selling stocks without any kind of brokerage fee. Binance allows users to trade their crypto assets. 

Savings

You can put some of your crypto into a DeFi savings account, let it run its course and earn very good interest rates. Crypto users can save money on the Hotbit platform. 

Insurance

You can use your DeFi holdings as some sort of insurance against bad fortune and unforeseen events. Opium Insurance offers tradeable, tokenised insurance offers. 

The benefits of DeFi

Speed

DeFi transactions are a lot faster than transactions from a centralised system, as the verification of financial transactions in DeFi happen in real-time. Interest rates and other variables update within seconds.

Transparency

Unlike traditional finance solutions, every DeFi transaction is recorded on the blockchain and available for all to see. There is a slimmer chance of corrupt money practices and diversion of funds.

Pseudonymous

With DeFi transactions, you do not need to provide your name, email, and other personal information; the only thing that matters is your wallet address. 

Lucrative

DeFi offers higher interest rates than regular banks and other centralised financial institutions. Due to the fact that the stakes are higher in DeFi, the rewards need to be commensurate with the risks being taken. 

The future of DeFi

At the rate at which it is going, DeFi shows a lot of promise for what it can be for the world. If it succeeds in disrupting the existing financial system, it will change the way we view and interact with money for a while. 

Seeing as the technology is still new, there has to be a lot of laws and regulations put in place before DeFi is accepted and adopted by the mainstream. It is still in its growing phase and holds a lot of potential for the global financial system.

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