Decentralized Finance (DeFi): Banking Beyond Traditional Banks

For many years now, the financial world has relied on one basic principle trust. For everything from getting a loan to opening a saving account or transferring funds across borders. One must rely on banks, brokers, and processors. In all these cases, there is always some intermediary are involve who imposes charges. Also makes sure that everything is done according to the rules and works only during working hours. DeFi, or Decentralized Finance, seeks to overthrow this concept and replace it with something entirely different based mostly on the technology of blockchains such as Ethereum.

How Does Decentralized Finance (DeFi) Work?

As opposed to TradFi, which involves a bank doing background checks of your identity. Also your credit score prior to lending money, DeFi works through computer code. When a user logs into his digital wallet, he logs directly into the program on the blockchain, not on any corporate servers. It verifies that transaction according to certain parameters. Need a loan? You need to put down a deposit in the form of crypto currency. Interested in earning interests? Deposit your funds into a liquidity pool for an algorithm to match you up with a borrower.

All transactions are kept publicly on a ledger. No one lends, no one notarizes, and there is no closing time.

Key Foundations of Decentralized Finance

• Accessibility in Decentralized Finance: One major benefit of decentralized finance is accessibility. Anybody who has an internet connection can partake in DeFi. There is no need to consider for any kind of minimum balances, credit checks, or geographical locations. This means that a poor farmer in rural Kenya would have equal access to a decentralized finance protocol to a trader in New York.
• Transparency in Decentralized Finance: Another key advantage is transparency. Banks can do as they please when it comes to determining interest rates and deciding whether to issue loans based on whatever criteria they may decide. The code is all open source when it comes to DeFi platforms. All transactions are visible to anyone.
• Custody and Ownership in Decentralized Finance: The next benefit of decentralized finance is that of custody. When dealing with a traditional finance platform such as banks, the financial institution takes custody of the individual’s funds. However, in a decentralized finance setting, an individual holds his/her own private keys at all times.

Risks Involved in Decentralized Finance

DeFi is not entirely risk-free. In fact, DeFi is considered the Wild West of finance. There may be errors or loopholes in the code written by humans in smart contracts. One wrong line of code may lead to millions of dollars of hacks. Moreover, due to the nature of cryptocurrency, there is a chance of liquidation after just a 20% dip in the market.

Another big issue is regulatory ambiguity since governments are yet to decide on taxing or regulating a technology that has managed to circumvent all of it.

The Future of (DeFi)

In spite of its risks, DeFi continues to evolve at a breakneck pace. While the total value locked up in DeFi platforms has been swinging into the tens of billions of dollars range, some of the leading financial players have begun tentatively experimenting with integrations. The underlying technology powering automated market makers and flash loans is now being examined by central banks in their effort to develop digital currencies.

While DeFi is unlikely to be able to do away with banks within any foreseeable timeline, it provides a tempting solution for creating a banking model which functions as a protocol rather than as a utility. To millions of people who lack bank accounts, as well as to technologists envisioning a more transparent future economy, DeFi is no less than an opportunity to completely rethink monetary architecture.