By FintechOS · June 23, 2022
5 minute read

DeFi-ing conventions: how crypto is decentralizing finance

DeFi-ing conventions: how crypto is decentralizing finance

DeFi technologies, such as cryptocurrency, are creating a multitude of opportunities that brands in the financial sector would be remiss to ignore. With the recent economic uncertainty of the past few years and the current cost of living crisis, the hype and push towards decentralized finance is gaining momentum.

When people use the phrase “decentralized finance” (DeFi), it’s generally meant as an umbrella term to cover the new and exciting financial innovations coming from the advent of blockchain technology.

Blockchain is a term that most of us are only aware of in relation to cryptocurrency. This isn’t a surprise since it was a system initially invented to support the inaugural cryptocurrency, Bitcoin.

A blockchain is a secure database or ledger maintained across several computers linked in a peer-to-peer network. When a new transaction occurs on the blockchain, a record is added to every computer in that network’s ledger, making it near impossible to cheat or hack the system. Any false or erroneous transactions would be immediately apparent.

The rapid advancements in blockchain technology are seeing it being applied to a vast range of industries suffering under archaic centralized systems. The most pertinent to benefit from DeFi being the finance and banking industries.

DeFi deconstructed

DeFi’s aim as a digital financial infrastructure is to essentially eliminate the need for a central entity to approve financial transactions.

The goal with DeFi isn’t to change what we do in the finance industry, but rather how we do it. By creating a more-robust and secure financial system, people will have access to a greater range of services at a lower cost.

In order to better understand the appeal of DeFi, it helps to first look at the current centralized finance (CeFi) system that is in place.

Centralized finance

With centralized finance, money is held by banks or financial institutions. Whenever money is moved around in the centralized system, third parties make money by charging fees for using their services.

Certain transactions in the CeFi system can also take a long time to process. While card transactions can be instantaneous, getting funds from a loan or a large sum transferred between banks can take days to process.

Decentralized finance

Decentralized finance doesn’t rely on third parties to make, or act as intermediaries during, transactions.

Instead, it allows people to create financial products and smart contracts (a self-executing contract where the agreement terms are written via lines of computer code) without needing to worry about transaction fees and delays caused by outside companies. No matter who you are or where you are in the world, as long as you have an internet connection, you can buy, sell, lend, trade, and borrow using blockchain technology.

The freedom of this DeFi system has led to innovation and creativity that the current global CeFi system just doesn’t have – perhaps the most famous example being non-fungible tokens (NFTs).

How does DeFi work?

Ethereum is the second-largest cryptocurrency marketplace in the world and a platform that developers can use to create blockchain apps. Most of the DeFi financial transactions take place over the Ethereum network via decentralized apps called dApps.

DeFi financial services use smart contracts and cryptocurrency to remove the need for any intermediary third parties.

For things such as lending and loans, this can remove the need for guarantors and allow borrowers to receive funds instantly. Peer-to-peer trades can be done without a broker or brokerage fees, and when saving or investing, DeFi allows for interest to be calculated/earned in minutes and hours instead of months.

How DeFi can be used

Being able to make simple and quick peer-to-peer transactions is one of the main drivers behind DeFi tech, but there are also a multitude of other popular applications:

  • Being able to send money anywhere in the world more quickly and with minimal fees compared to other current CeFi methods
  • Storing money in crypto wallets where you can earn higher interest than with CeFi banking
  • Quick peer-to-peer borrowing and lending
  • Crowdfunding
  • Trade not only cryptocurrencies but also ‘tokenized’ versions of stocks, investments, and NFTs

Is DeFi the future?

While it’s impossible to say when and if DeFi will completely overtake the current centralized financial system, it’s rarely possible to put a genie back in its bottle. Despite being in its infancy, DeFi has shown numerous benefits for consumers and there are positive signs that cryptocurrencies, dApps, and DeFi protocols will be the future of finance.

As it’s still in its infancy, DeFi is, as a whole, an unregulated space. Since blockchain technology allows for borderless transactions, it doesn’t adhere to or fit the rules, laws and jurisdictions set for the current global CeFi system.

While it will be some time until there is a regulatory system in place to make the DeFi ecosystem an entirely safe and secure space, it’s worthwhile to have a basic grasp of the technologies and potentially new ways of working that are emerging from the movement.

Why banks should take note

The benefits of DeFi for consumers are obvious, but should banks be wary of this space as a challenge to their authority? Only if they refuse to take advantage of the rise of DeFi.

Established industry players from VISA and Mastercard to Revolut are working to enter the DeFi space in order to follow the market to where there customers want to be. Financial institutions that are going digital have nothing to fear from the decentralization of finance. It’s only those that remain wholly in the CeFi space whose days are numbered.

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