Insights #2 Basics of Decentralized Finance
Decentralized finance, commonly known as ‘DeFi’, is a movement focusing on the development of a decentralized ecosystem for financial services, as opposed to the traditional, centralized system which has been at the forefront of this sector for many years.
Being one of the most prominent components of the blockchain and cryptocurrency industry right now, it comes with many advantages over the financial structure we have at the moment. This new system will transform the global financial institutions increasing equality and economic mobility worldwide.
Why DeFi is unique and will roll over the current centralized financial system
DeFi can drastically reduce what is known as ‘geographical lottery’- Access to basic financial services is available to everyone with an internet connection 24/7. According to a World Bank report, currently 2 billion people worldwide do not have access to a financial institution or bank account. Blockchains give us the opportunity to establish a financial system open to all globally and as a consequence drastically reduce global inequalities exacerbated in the last half century.
Unlike the traditional financial structure in which data is kept on a central server, records in DeFi are kept across thousands of nodes worldwide decreasing the risk of malicious hacking attacks.
No central authority is required to validate transactions on a network. By cutting out the intermediary, the savings and efficiency of transactions are amplified.
The blockchain is a public network therefore transactions are visible to all. The current system is extremely opaque with institutions frequently making their consumer offerings within fine print, often engaging in shady practices to maximize their profits.
As a result of the centralized financial structure we have at the moment, 70% of people in the world have land have a tenuous title to it. Therefore, countries with poor governance and authoritarianism can use their centralised authority to financially censor their citizens by freezing accounts, removing funds and ejecting people from their land. Through DeFi, records will be immutable, preventing one party or entity from invalidating transactions, and so increasing economic mobility and prosperity for all.
Developers using DeFi services have the ability to program business logic and create financial services at low cost. This is mostly due to the emergence of smart contracts.
As a consequence of DeFi remaining significantly underdeveloped as well as coming with several challenges which must be overcome, it is crucial that it starts by providing an alternative option to the current system, instead of a direct replacement for it. What is needed is a gradual and profound shift from centralized to decentralized finance, with in the meantime, the creation of a hybrid model whereby both systems work in tandem.
Emerging DeFi applications
Numerous projects are launching to try and level the playing field. DeFiPrime does a great job aggregating those projects and providing in-depth content with DeFi founders and developers. Below is a non-exhaustive list of interesting DeFi use cases.
Using smart contracts, companies provide guarantees of compensation for specified losses, in return for payment or premium.
A derivative is a contract that derives its value from the performance of an underlying asset. Blockchains increase derivatives efficiency by lowering the cost to access as a result of the creation of contracts and elimination of counterparty risks.
Allows users to be in full control of their digital identity. These services also offer shared regulatory compliance services for individuals, in order to prevent money laundering and financing.
Interest Earning & Lending
Numerous platforms provide loans to businesses or individuals without intermediaries.
Decentralized Exchanges (DEX)
Allows individuals to trade digital assets peer to peer while holding complete control over their private keys.
Opens real-world assets to people who previously may not have been able to invest due to geographic or financial restrictions. Through tokenization, investing is cheaper, faster and more secure.
Allow for truly peer-to-peer exchange of goods and services by operating without middlemen and having limited to zero restrictions, permitting people to buy and sell whatever they like.
Cryptocurrencies created to decrease the volatility of coins price, relative to some asset therefore, decreasing the risk that you have paid too much or too little for a good or a service. There are three types of stablecoins: Fiat collaterized stablecoins, Crypto-collaterized stablecoins and Non-collaterized stablecoins.
Markets created to trade on the outcome of all types of events.
Custody and Asset Management Tools
Individuals are the only one in control of their private keys and funds. This allows individuals to have complete custody of their blockchain-based assets.
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