With the rise in popularity of blockchain technology, cryptocurrencies and NFTs, DeFi or Decentralized Finance is another popular term that intrigues many people either as an interesting possibility for building the future global financial models or as an alternate area of investment.
Whatever the case may be, decentralized finance seems like a concept worth exploring. Who knows, it could actually govern the future operations of all the banking institutions. Therefore, understanding decentralized finance becomes imperative as it could impact our financial system.
In this article, we’ll explore the meaning of decentralized finance in the simplest terms. The further sections in the article will elaborate on decentralized finance and cryptocurrency, some features of decentralized finance, and the future of decentralized finance. Read till the end to learn interesting facts!
What Is Decentralized Finance?
The most simple decentralized finance definition would describe it as a blockchain-based financial system. As an economic mechanism that runs on a distributed ledger, decentralized finance implements smart contracts and consensus mechanisms to record transactions and verify the transfer of funds.
Therefore, the role of centralized intermediaries is brought to a negligible level, leading to the decentralization of finance and establishing the decentralized finance mechanism.
Decentralized financing is capturing the attention of individuals and organizations, given the advantages decentralized finance offers.
By eliminating the role of third parties like banks and other financial institutions, decentralized finance DeFi eliminates the fees charged for the services provided by the financial bodies.
Decentralized finance enables people to keep their funds in a secure digital wallet instead of holding them in a bank.
In addition, with decentralized financing, anyone with an internet connection can trade and transact money without waiting for approvals. As a result, the time that is usually taken to execute transactions and fund transfers is reduced to minutes and even seconds with the implementation of decentralized finance.
Understanding Decentralized Finance
Decentralized finance eliminates go-betweens by enabling individuals, vendors, and enterprises to carry out financial transactions employing emerging technology. It is done through community financial networks that utilize safety protocols, internet access, applications, and equipment advancements.
One can loan, exchange, and borrow using decentralized finance applications that record and verify financial transactions in distributed financial databases from anywhere you have an internet connection. A distributed database is accessible from multiple places; it gathers and analyzes data from all users and verifies it using a consensus mechanism.
Decentralized finance uses blockchain smart contracts and consensus mechanisms technology to eliminate centralized finance models by allowing anyone to use financial services anywhere regardless of who or where they are.
Through personal wallets and trading services tailored to individuals, DeFi or decentralized finance applications give greater control over their money.
An essential fact to note is that decentralized finance does not provide confidentiality while removing control from third parties. One’s transactions may not bear their name, but they can be traced by the entities who have access to them. These entities could be governments, law enforcement bodies, or any other organizations whose responsibility is to protect people’s economic rights.
Decentralized Finance And Cryptocurrency
The relationship between decentralized finance and cryptocurrency is quite direct and dependable. Cryptocurrency is the medium or instrument which is used for performing transactions in decentralized finance.
Since decentralized finance, as a new paradigm of financial management and mechanism, is still in its developmental stages, the implementation of existing decentralized finance crypto in the emerging decentralized finance model seems unclear.
However, to a great extent, the concept of decentralized finance circles around stablecoin, one of the different kinds of decentralized finance crypto either backed by some entity or secured by a fiat currency such as the dollar.
Is Decentralized Finance The Future?
Brad Yasar, the founder and CEO of EQIFI, a company that aims to simplify decentralized finance for all, suggests that decentralization is the future of finance.
There are several lucrative features that decentralized finance offers. When the traditional financial institutions would gradually materialize those features, a more inclusive and valuable model of decentralized finance would be seen than it exists today.
Therefore, the decentralization of finance could impact the banking sector by making it more fair and just. For example, banks don’t prescribe double-digit returns on people’s money in the present scenario, even if possible. However, with the decentralization of the financial system, people would get those returns from decentralized finance banks.
Adding another point for how decentralized finance could be the future, Brad says, “decentralization is the future because it creates a more resilient structure around the goals. If one has a centralized model, it has chances of a single point of failure. Suppose, if the server clusters go down, then the business would go down. But with a decentralized finance model, they don’t have the risk of a single point of failure.”
Besides these points, given below are the exact features that would better explain how decentralized finance could significantly add to making the future of finance.
- NON-CUSTODIAL – The distributed blockchain networks enable people to control their assets and data, as well as transfer value from one person to another without the use of intermediaries. Only users have access to and control over their wallets. This feature is called “non-custodial” because DeFi decentralized finance apps do not have custody of the users’ assets.
- OPEN – The decentralized finance networks are also widespread, implying that the sequential financial system has no borders and that anyone can access it. It’s similar to the internet, but rather than the information being transferred globally, seamlessly, and creatively, money is transferred in that way, making it a network offering value.
- TRANSPARENT – Anyone can view and inspect the commands for the decentralized finance DeFi applications. This is significant because anyone can test the applications and protocols, tracking their monetary transactions’ exact position/status.
- COMPOSABLE – Since the code is open-source, developers can compose new features on existing applications. It also accelerates innovation and development in the possible solutions these decentralized finance DeFi applications could provide.
- DECENTRALIZED – Lastly, decentralized finance is a concept built on the base layer of decentralization. Thereby giving users the ownership of their financial applications. The users will be able to participate in major decisions, propose changes, and benefit from the growth of the DeFi decentralized finance application.
Future Of Decentralized Finance
Decentralized finance is still in its initial phases of development. Therefore, it is quite unmonitored, implying that the framework is still beset with infrastructural malfunctions, hacks, and scams.
This points to the fact that the future of decentralized finance to be effective would require setting clear guidelines to preferably prevent and, if in case needed, curb the losses from decentralized finance infrastructure malfunctions.
Current legislation on decentralized finance is based on the concept of different economic jurisdictions, each with its own set of rules and regulations. Therefore, the ability of decentralized finance DeFi to conduct borderless transactions raises critical issues in this context.
It would pertain to matters of authority and the final say in the verdict or decisions relating to important decentralized finance issues.
For instance, who would be the in-charge of investigating DeFi decentralized finance crimes across borders, formulating the protocols on the application of decentralized finance, enforcing the rules regarding DeFi decentralized finance, and how these rules and protocols would be implemented.
In addition, there are other issues to consider too, which include stability of the decentralized finance system, the energy consumption and environmental impact of decentralized finance cryptocurrency, infrastructure upgrades, maintenance costs, and equipment failures of decentralized finance DeFi.
So, several issues need to be addressed, and progress needs to be made before DeFi decentralized finance can be used confidently.
Banking institutions are also less likely to give up one of their primary sources of revenue. Therefore, if DeFi or decentralized finance succeeds, corporations and banks might very well look for ways to get into the system, if not to handle the accessibility of money, then find ways to avail financial gains from the decentralized finance.
The following four points could ultimately summarize the future of decentralized finance in terms of the areas of its application, which are as follows:
- STABLECOINS – As explained under the pretext of decentralized finance crypto, stablecoins would be a prominent instrument instigating greater acceptance of decentralized finance.
- DERIVATIVES – Next would be decentralized finance derivative platforms to ease the availability and accessibility of stablecoins and decentralized finance crypto. Synthetix, Nexus Mutual, and Augur are some of the DeFi decentralized finance platforms.
- PAYMENTS – With decentralized finance derivatives that have the terms of agreement encoded in smart contracts, the settlement of DeFi decentralized finance transactions automatically takes place on-chain without taking too much time.
- INVESTMENTS – Lastly, investments in the decentralized finance sector would promote the adoption of open and transparent transactions between individuals and organizations, helping investors know more about each.
FAQs – Decentralized Finance
Here are a few questions on decentralized finance that could significantly help in clarifying your foundational understanding of the decentralized financing system and its meaning.
Q.1 What Is Decentralized Finance?
A decentralized finance system is a new financial system of open-source technologies, blockchain technology, and proprietary software. Smart contracts make the decentralized finance or DeFi financial products possible, which optimize agreement terms between market participants or lenders and borrowers.
Q.2 What Is Decentralized Financing?
Decentralized financing is a shift from traditional centralized financial technology that allows peer-to-peer financing toward a more decentralized and permissionless system.
Decentralized financing is provided by a code that runs on a decentralized and distributed infrastructure. In contrast, centralized economic systems are run by exchanges where transactions are moved from one central location to another.
On the contrary, the goal of decentralized financing is to create decentralized finance services using blockchain, smart contracts and consensus mechanisms.
Q.3 Why Decentralized Finance?
Decentralized finance DeFi is preferable to a centralized financial system because it includes highly programmable smart contracts that automate execution and allow the creation of new financial instruments in the form of digital assets.
In addition, the blockchain architecture increases the security and verifiability of the data. The implication of this would be that transactional information under decentralized finance will not be manipulated or tampered with in any manner.
Moreover, DeFi decentralized finance protocols and applications are integrated and complementary because of the composite software stack. Therefore, each transaction on the public blockchain is broadcast for verification by other network users.
Q.4 Why Decentralized Finance Tokens Are Skyrocketing Today?
The popularity of decentralized finance cryptocurrency tokens is skyrocketing because of several reasons. Firstly, the provision of smart contracts for decentralized finance would assist in providing a collateral guarantee to the lenders in case of a default. Consequently, the rate of interest is kept low.
Secondly, DeFi decentralized finance is also democratizing the fine art market. Through NFTs or Non-Fungible Tokens, individuals and enterprises have the opportunity to enter the art and collectibles market. They curate unique content such as videos and images as digital assets and then mint NFTs on the blockchain. Here, decentralized finance cryptocurrency plays an important role in simplifying transactions.
The Bottom Line – Understanding Decentralized Finance
Decentralized finance would be the future of the financial sector, something only time will tell. However, the features offered by the DeFi decentralized finance are worth exploring and acknowledging. In addition, the widespread application of decentralized finance cryptocurrency could also bring about greater acceptance and adoption of decentralized finance as a concept.
Based on blockchain technology, smart contracts and consensus mechanisms, developments in the sphere of decentralized finance would also enhance the application of blockchain technology. They might help establish a fair, just and transparent economic system driven by and for the community.
Author: Nitisha Lal
Nitisha Lal is a writer enthusiastic and curious to learn new things. Currently, she writes about the latest developments in technology, particularly around Web3 and the Metaverse. She enjoys nature walks, capturing the world around her on the phone, or reading books when away from work.