The world of cryptocurrencies is based on a speculative basis. However, it is blockchain technology that makes cryptocurrency so accessible. Finance is no different. Let’s discuss decentralized finance and how it will change the way the world of finance works.
Crypto Encourages Financial Institutions to Take Steps into the Future
Trying to understand how decentralized finance works? To help you, we will delve into the essence of decentralized finance and how it works. Let’s get started!
DeFi: What is it?
Decentralized finance (DeFi) is a monetary system that uses public blockchains. This is a new monetary system, and therefore it is one of the hot topics for industrialists, blockchain experts, and the curious like you and me.
In fact, the term “public” is important here. It can be equated to the public Ethereum blockchain. There is no place for centralized power in a public blockchain.
The need for DeFi is driven by the fact that financial services are not available to everyone around the world. Almost 1.7 billion people around the world do not have the means and access to financial services. Financial institutions also fail to provide the necessary infrastructure to make it easier for people to access money. The existing infrastructure is huge, but it is not enough to cover everyone.
With the help of decentralization, current infrastructure failures are eliminated. This eliminates the point of failure and ensures that records can be stored and shared by different nodes on the network. It can work in a peer-to-peer network without any centralized authority.
For the current infrastructure to work, there is an over-reliance on centralized power. Without its governance, rules, regulations and reach, this cannot be implemented in some areas, especially in places where the creation and distribution of wealth is less or insufficient.
In addition, a centralized authority has the right to delete accounts or block them if they deem it necessary. In some cases, censorship may be necessary, but in most cases it is only restrictive and causes users to suffer.
Another key element of DeFi is decentralized applications (dApps). DApps allow financial institutions to build functional applications on a public blockchain and ensure that anyone can interact with them at minimal cost.
Decentralized Finance Approach
Now that we have the answer to the question “What is DeFi?”, it’s time to learn how to apply it.
From the start, DeFi seemed promising. It can change the lives of many people and help to use infrastructure that does not require a centralized approach.
- Solution for the money transfer market
The most significant impact of DeFi will be on the money transfer market. The market supports the idea of sending millions of dollars across the border by workers working in foreign countries.
They have a lot of problems sending money. One of their biggest concerns is the amount of commission they have to pay to complete the transfer. If a person earns little, it will be very difficult for him to collect the necessary amount to send, and cover all the commissions.
With the help of decentralized financing, it will be possible to reduce the costs associated with sending money by 50% or more. Using DeFi, you don’t have to worry about sending payments across borders. Ethereum-based financial applications are more popular here.
Decentralized finance is also very useful when it comes to managing loans. In general, the credit industry is very dependent on access to banking.
If you don’t have access to banking or similar services, you can’t take out a loan. This means that you also need to have a proper credit score or bank record that you can produce to prove your eligibility for the loan.
With DeFi, all this will change. The platform can solve connectivity issues between lenders and borrowers. They will connect them better and directly. In addition, it will provide better credit verification and ensure the rapid transfer of digital assets.
There are many Ethereum-based applications that offer credit services.
Another extremely good use case for DeFi is its use in stable coins. Stablecoins are created in such a way that their value does not change. Decentralized finance coins are mostly stablecoins, and they are an important part of this technology.
These are digital currencies that can be used by the population as money. Central banks are trying to use it as a currency issued by the government.
In fact, it makes it easier to tokenize real assets. Real assets can be added to the blockchain and therefore sold on the blockchain. Storing assets on the blockchain means better security and less exposure to cyber threats.
Traditional and decentralized finance
What distinguishes traditional and decentralized finance? The main difference is how they work.
Traditional financial systems operate with centralization, which leads to inefficiency and insecurity. Security risks persist in the current traditional financial system. Cybercrime is also on the rise due to the lack of evolution of the technologies used by the financial institution. Most transactions are at risk of being hacked. All of this entails financial and data-related risks.
DeFi, on the other hand, ensures that problems are fixed to a certain extent. Essentially, DeFi uses a public blockchain. This means that it does not rely on a centralized system or object. It can work without the need for proper infrastructure.
It simply decentralizes the global economy and makes economic activity accessible to everyone around the world. Public blockchains can effectively replace the traditional financial system and make it transparent, decentralized and permission-free.
Let’s discuss the improvements it brings:
- No permissions: the public blockchain does not require anyone’s permission to join and interact. This makes them an excellent choice for global deployment. This also ensures that the inequality problem is solved.
- Decentralization: Without centralized management, data is stored between different nodes in the network.
- Transparency: The public blockchain is also transparent.
An example of decentralized financing includes Rainier AG. It is an independent asset management firm that uses cryptocurrency to its advantage. They have created a proper STO exchange platform along with a cryptocurrency trading platform.
They are currently working to improve their ecosystem by offering unique services in the financial sector.
The risks of decentralized financing
When it comes to DeFi, not everything is good. Some challenges need to be addressed to make it more viable for various governments and organizations.
One of the biggest challenges that DeFi has to face is the speed of adoption. Even though we are connected via the internet, we rarely hear about DeFi.
Not many people know about the technology, and this can affect the speed of its use. In fact, there are very few people who know about cryptocurrency. The cryptocurrency gained its popularity during the rise of Bitcoin prices, and yet it is far from the “Internet” or other more popular technologies.
Despite the fact that public blockchains are technically capable of accepting each of us, they do not have enough bandwidth to work effectively. By comparison, Visa can process a huge number of transactions per second.
This limitation is what has prevented Bitcoin from becoming such a big success in terms of adoption. In fact, other second-generation blockchain solutions, including Ethereum, lack the bandwidth to make them more attractive in the real world. Right now, blockchain researchers are working hard to make the technology more scalable.
Another big problem for DeFi is the connection to cryptocurrencies. Blockchain is an ideal network for transferring digital assets.
Stable coins are the answer, but they can’t be used for every transaction. This is where cryptocurrencies come to the rescue. But the volatility nature of cryptocurrencies does not make them an ideal solution for the real world.
Why is decentralized finance so popular?
You should be wondering why DeFi is so popular among financial institutions? Well, as you can see, this has many advantages. For example, in the long run, this will provide you with greater security and transparency.
In addition to the implementation work, it is also necessary to ensure that there is an appropriate regulatory framework. Since this is a public blockchain, it is necessary to introduce rules.
Several DeFi organizations are currently working on their own solutions. Their decisions are independent and therefore do not follow any recommendations.
This creates a fragmented market that will be difficult to create in the near future. With the advent of more and more DeFi platforms, we can’t find any of them successful, wasting time, money and risking the idea.
There are also countries that ban cryptocurrencies or regulate them too tightly to make them difficult to use.
The solution is to have an open source regulatory organization that could work together to bring projects together. By doing so, we can ensure that DeFi can grow in the right direction.
The rise in popularity
Blockchain, like Bitcoin, is 12 years old. However, we didn’t see the popularity of DeFi until 2019. This is due to the fact that most of the world was not connected via the Internet.
It is thought that by 2025, DeFi will become more popular. The Internet is growing fast and becoming more accessible than ever. India, one of the third world countries, has also seen huge growth in mobile and Internet connectivity.
Currently, the future of decentralized finance seems pretty bright. Many companies already consider them as an alternative to traditional ones. Also, many companies have already taken the necessary steps to implement projects with this innovation.
So it looks like acceptance will grow. So, if you work for a financial institution or similar company that deals with finance, you should definitely take a look at DeFi.