Decentralized Finance, abbreviated as DeFi, has been a trending topic in many circles. Before heading to DeFi’s what, when, and how; I wanted to talk about Centralized Finance. Let us understand the whole landscape.
What is Centralized Finance?
Centralized Finance means centrally controlled. In this case, it refers to the financial institution that is the banks. While centralization began with the aim to stabilize the global financial markets and deemed necessary for cross-border businesses, many shortcomings have surfaced like forgery, fraud, and even questionable lending processes and so on. Even though the financial institutions are widespread, they still remain inaccessible to many.
What is Decentralized Finance?
This brings us to a decentralized system, which is comparatively new and built on open-source networks. DeFi aims to override limitations that we see in the traditional financial market by offering financial products and services on blockchain-enabled peer to peer networks. DeFi includes dApps built on blockchain networks along with protocols, digital assets, and smart contracts.
Imagine DeFi as an ecosystem made up of several small financial tools and services. They can be modified, integrated, and combined as per one’s need. DeFi gives you complete control of the assets by eliminating the middleman. This is only possible because of decentralization and blockchain technology.
How De-Fi works?
Anyone can build new financial products since all protocols are open-source. Across the world, developers collaborate to build new products; thus enabling faster and safer innovations. dApps are efficient, accessible, cost less, and offer faster operations.
Compared to a centralized financial system, anyone can earn a higher return on their investment as well as invest, trade, and store their assets in blockchain safely. With no intermediaries looking after your asset, you are in control of your own investments.
Features of DeFi:
1. With no central control or intermediaries, a DeFi system will hardly be affected by fraud, manipulation, etc and still be powerful enough for safe, transparent, and reliable financial transactions.
2. With DeFi, a user will have access to a global and open alternative for all the financial services like loans, savings, mortgages, and so on with just a smartphone and an internet connection.
3. DeFi has no regulatory barriers to access the decentralized ecosystem.
4. dApps are built on open-source protocols. This means anyone can contribute to the code and it is open for anyone to audit or find bugs.
5. The control of a user’s assets remains in his hands and not a bank or intermediary.
6. dApps can be built by combining or composing other DeFi products.
7. A central party has no authority to change transfer, exchange, and token custody.
The biggest impact of such a system will be felt by communities that have no association with banks. With requirements only being smartphone and internet connection, these people would have easy access to a global financial market.
Using permission-less public blockchains, easy lending is possible. Loans can be granted cross border using smart contract technology. Smart contracts are digital contracts that are programmable and auto-execute agreed-upon terms and are applied to assets.
The important thing to know here is that cryptocurrencies have not decentralized the whole financial system however they have decentralized the storage and issuing of money part. The following are two reasons why this financial system isn’t genuinely decentralized:
1. Even though cryptocurrencies are decentralized, they still access exchanges which are centralized.
2. Many crypto projects fall under centralized companies, accountability, and transparency for which is lacking.
Other factors like scalability and volatility are also big concerns in the cryptocurrency space.
While DeFi remains tiny as compared to traditional finance, it has become very popular since last year. It is hard to believe that decentralized finance will replace the centralized finance market completely. Nonetheless, decentralization offers a promise and it is a rare opportunity to see new industry progress from scratch.