For centuries, we have seen lending and borrowing. Before banks came into picture, people used to borrow from other wealthy person in their vicinity.
These loans were taken either to start a business, expand the current business or some personal needs. Based on your relation with other wealthy person, rate of interest used to vary in north of double digits.
Later banks came into picture. Though they smoothened the process and lowered the interest rates, still getting loans from a bank involved lot of work, like submission of documents for KYC, proof of capacity to payback the loans.
One can say that in this important area of finance, most part are managed by centralized systems, long-established and governed by authorized banks and financial bodies.
Traditionally, if a consumer wanted to take a vehicle loan or mortgage on a new home or buy stocks or invest in funds or avail any kind of financial service, they would need to go through some form of middleman, namely the governing financial bodies like
banks, exchanges etc.
There are two parts in this, which require changes.
- In case of lending, banks and exchanges earn some percentage of the profit resulting from these transactions.
- Also, to ensure security, these agencies apply gatekeeping measures (KYC checks) for those requiring these financial services.
Due to this, the process becomes lengthy with many people involved and can create friction points in the formal credit system.
Now, with help of technology, radical changes are coming in this. Technology is helping borrower with lender directly, without any need for any middleman or central agency.
This is one of the major reason, why Decentralized finance is becoming popular.
Decentralized finance aims to cut out the middleman, and making lending and other financial transactions possible and more convenient between peers directly.
Today, DeFi services can be enabled for a number of crucial areas of finance from lending to borrowing, funding, trading, derivatives, and insurance.
Diving deep into DeFi
Decentralized finance is the idea of managing money without large institutions or corporations.
It is established through peer-to-peer transactions, which means that more of the work done by banks and other financial institutions is taken up by individuals.
It’s based on open-source technology without a controlling authority to deny access to any financial product/services sought by users. It also facilitates market exchanges round the clock.
DeFi is based on Blockchain technology, which enables financial applications and protocols with programmable functionality.
Transactions on the blockchain are carried out automatically by smart contracts that include deal agreements.
Smart contracts include terms of agreement and the deal struck between concerned parties. These contracts set up a rules-based ecosystem where financial transactions such as lending, and investing can take place without needing third parties like banks and
The transactions happen automatically when the conditions of the smart contract are met, as opposed to traditional finance where many people and systems can be involved in processing, verification, and logging of transactions. Transaction records are maintained
on the immutable ledger and independently verified by thousands of computers around the globe.
Benefits of DeFi
Blockchain technology provides decentralized finance, which increases financial security and transparency, unlocks liquidity and growth possibilities, and supports an integrated and standard economic system.
There are many benefits of DeFi.
Smart contracts allow the creation of new financial instruments and digital assets and automate the execution of these contracts.
Programmability of the money is a very powerful concept. So, money will be released or taken back, only after certain condition is met.
Going forward, we should see use of this concept in various government schemes. Think of the scenario, where government is releasing money to the needful only after it is ensured that necessary criteria is met.
Using DeFi, developers and product teams can combine established protocols with multiple custom interfaces, as well as integrate third-party applications. As a result, DeFi protocols are sometimes referred to as “money legos.”
A public blockchain broadcasts all transactions for other users to verify. In addition to allowing for rich data analysis, this level of transparency surrounding transaction data also ensures that network activity is publicly accessible.
DeFi protocols are also part of Ethereum, and the code for them is available to anyone who is interested in viewing, auditing, and building upon it.
A key characteristic of DeFi over traditional finance is its permissionless, open access: anyone with a crypto wallet and access to the Internet, regardless of geography, is usually able to access applications built on Ethereum with a minimum amount of funds.
Participants in the DeFi market always keep custody of their assets and control of their private data because they use Web wallets in conjunction with permissionless financial applications and protocols.
DeFi is based on open-source technology. This allows everyone to access the financial using internal connect and apps.
From a consumer perspective, with just an internet connection, individuals can conduct financial transactions with peers. All the transactions are recorded in distributed databases, which are accessible to relevant actors in that system. This helps in establishing
the digital trail of all the transactions.
As no central agency is involved, overall process is very smooth & cost-effective.
Also, the programmability concept gives lot of options to various actors in the financial ecosystem. It can really cut down the inefficient & error prone processes as well as remove the corruption in the system.
This system promotes transparency and accountability with data hosted on a decentralized database. This database is highly secure through the use of cryptography and erases the need for an institution, such as a bank or broker, to verify transactions.