Decentralized Finance – an emerging trend in the financial world, which some see as a potential revolution in the traditional financial sector. DeFi’s goal is to create a financial system that is efficient, transparent and accessible to everyone. Discover what is behind this effort, what the benefits, as well as challenges, are, and which projects are highly relevant in DeFi right now.
What is DeFi?
DeFi – short for Decentralized Finance – combines the structures and products of traditional finance with blockchain technology. By moving traditional banking and financial services to the blockchain’s decentralized infrastructure, intermediaries such as banks, brokers and agents are bypassed. Transactions take place according to the peer-to-peer principle, allowing transactions between two parties to be processed via smart contracts without intermediaries. Smart contracts are self-executing, digitized contracts on the blockchain and include all the terms of the transactions.
What is the difference between DeFi, FinTech and Open Banking?
FinTech and Open Banking are terms that, if you’re interested in finance, you’ve definitely heard before. It seems reasonable to ask what exactly the difference between the three is, as all three make use of technology to improve the financial market.
The crucial difference is that while Open Banking and FinTech continue to adhere to the financial market’s traditional structures, DeFi proposes an entirely new financial system. Thus, the efforts of FinTech and Open Banking are creating new financial instruments, products, and services, while continuing to rely on intermediaries. DeFi, on the other hand, based on blockchain, breaks away from this traditional infrastructure.
What does it take to use DeFi?
Actually, it doesn’t take much: In order to use blockchain-based DeFi, you primarily need an internet-enabled device. In addition, you only need a wallet to protect coins and tokens from unauthorized access.
Advantages of DeFi
By now it should be clear that middleman-eliminating DeFi is not only more cost-efficient, but also time efficient. However, DeFi offers other advantages, because by transferring traditional financial services to the blockchain, it bypasses the problems of the traditional financial sector:
1. No exclusion
With Decentralized Finance, anyone can create a wallet and start trading, regardless of whether they have a bank account or not. Thus, unlike the traditional banking sector, no one can be rejected due to lack of creditworthiness or a bank account. Moreover, anyone can participate around the clock, from anywhere in the world.
2. No censorship
The same rules of who can use DeFi also applies to currencies. You are not limited to the currencies specified by the centralized authority, but can use alternative forms of capital.
3. No third-party trust issues
With DeFi, there is no need to trust anyone with your money, as you control your finances yourself. Thus, there is no need to worry about the trustworthiness of any institution, company or person: only the smart contracts.
4. High transparency
Blockchain technology allows high transparency due to the transaction’s full traceability. In addition, DeFi also avoids the risk of hidden costs, clauses or opaque contracts.
5. High return opportunities
While the traditional financial sector is currently characterized by strong low-interest rates, it is possible as an investor to generate high returns with DeFi. Methods like lending, staking, liquidity mining and yield farming are central concepts here.
Challenges and risks of DeFi
Although DeFi offers many advantages compared to the traditional financial sector, if returns are to be expected, there are always some challenges and risks to consider.
Among others, these include problems with smart contracts. In the past, it has been quite common that errors in the codes of smart contracts were not discovered despite numerous reviews of the source codes. This could lead to third parties profiling themselves. In addition, the entire responsibility is transferred to the users, which means there is a high risk of user errors. Therefore, it is imperative to study DeFi in detail before taking your first steps.
The TeachMeDeFi team offers an online course that can help you understand the basic elements of decentralized finance and give you the skills you need to succeed in the emerging world of financial systems.
Projects and applications
To get an idea of the possibilities DeFi offers, you can take a look at some projects that are currently of great relevance. For example, platforms such as Compound or Maker enable the lending and borrowing of crypto assets. Raising funds can also be designed without middlemen, and issuance platforms like Polymath play a central role in this. Open marketplaces such as OpenSea, which unlike platforms such as Amazon, realize decentralized commerce via smart contracts settlement, are also gaining in importance.
The potential of smart contract-based asset management or decentralized stock exchanges is also particularly interesting to observe and is likely to evolve and improve significantly in the years ahead.
Taking out loans, earning interest, buying insurance – all these traditional financial sector services could be replaced by decentralized finance in the future. Consequently, the innovative movement could use new technologies and blockchain to reshape the financial system in a new and decentralized way. However, DeFi is still in its infancy and although the community is growing steadily, there are some hurdles in the way that investors should consider.
Therefore, we recommend taking a closer look at DeFi, before taking full advantage of its potential.