Financial crises seem to be a recurring phenomenon. After the subprime mortgage crisis, we’ve now seen the Equifax breach, Cambridge Analytica scandal and so on. The list of financial scandals is long and extensive, revealing the fragility of current models and regulatory measures that are in place. The social and economic costs of these financial crises are massive. They lead to unemployment, poverty, recession, etc. And because of this frightening pattern of instability, many are trying to find solutions for future problems before they arise again. One solution might be decentralised ledger technology (DLT), more commonly known as blockchain technology. Blockchain has proven its potential in finance over the last few years through cryptocurrencies such as Bitcoin and Litecoin. However, other fields such as healthcare and logistics have been using blockchain technology for some time now to solve different problems.
Also read: The Future of Finance: Why Decentralized Finance is Here to Stay.
What is blockchain?
A blockchain is a decentralized ledger that records and verifies data. It enables peer-to-peer (p2p) transactions without intermediary parties: no banks, no centralized authorities, no one to be corrupted by someone. It is a distributed database where data is stored on a network of computers – a decentralized system. This means that no one computer is “in charge” of the system, i.e. no one person can control the blockchain. The blockchain works as follows: First, individuals exchange assets/data with each other through a peer-to-peer network. Then, they submit their transactions to the network. Once a block is filled with transactions, it is verified by the network to confirm that it’s legitimate, and then added to the blockchain.
Defi: The Blockchain Solution
Decentralized finance (DeFi) is a form of financial services that utilises the distributed ledger technology (DLT) of blockchain to enable the creation of decentralized financial applications. DeFi is a new type of financial model that aims to disrupt the centralized finance model. It does this by removing the need for trusted intermediaries and centralized entities for services, such as payments, lending and investing. A centralized model is one that has a central authority that acts as a ledger and is responsible for keeping track of all the transactions, as well as other financial data. Centralized models are the norm in financial services, like banking, lending and investment. Cash, stocks, and bonds are examples of centralized assets. Centralized models are susceptible to fraud and theft, so intermediaries, such as banks, are needed to act as trusted third parties to keep track of the data.
What is DeFi and how does it work?
A decentralized financial application is a system built on top of a DLT like Ethereum or Bitcoin. It decentralizes the way financial services are provided by removing the need for a central authority. Decentralized finance (DeFi) is a term that has been used in the cryptocurrency community since mid-2018. According to Buterin, DeFi is “the idea that smart contract-based financial services such as savings accounts, insurance, and others should be fully decentralized and autonomous”. The decentralized financial application model is based on the idea of removing intermediaries and central authorities. All the functions of the centralized model are done by the blockchain system. The blockchain acts as the ledger and data is stored within the system.
DeFi vs. centralized finance
The most obvious difference between centralized and decentralized finance is that the latter does not rely on a central authority. Instead, all the functions of a centralized financial model are done by a distributed system. Therefore, if they are not already, intermediaries will eventually become redundant. Usually, a centralized model is one that has a central authority that acts as a ledger and is therefore responsible for keeping track of all the transactions, as well as other financial data. Meanwhile, in a decentralized model, no one computer is “in charge” of the system, i.e. no one person can control the DLT.
Risks of DeFi for investors
Even though decentralized finance has many advantages, it also comes with some disadvantages. The main risk for investors is the potential for volatility. With decentralized finance, people will also be able to short Bitcoin, which means that they can sell Bitcoin that they don’t own yet. This has the potential to drive the price of Bitcoin down. In other words, it can be risky business. One way to address this potential volatility is to have a diversified portfolio. In other words, the more different assets you invest in, the less volatility you’re likely to see from one asset.
Key benefits of DeFi
Security – A DLT is a blockchain system that does not depend on a single entry point. Therefore, there are multiple nodes (computers connected to the system) that can keep track of the data. This means that no one computer can be hacked and the data stolen. Users are also protected from malicious activities, such as manipulating the data. No Intermediaries – Intermediaries are the entities in centralized finance that have to be involved in every transaction. In a decentralized model, the blockchain acts as the ledger and no third parties are needed. The users will not have to pay any fees or interest rates. Flexibility – A decentralized model offers different types of virtual or physical assets (money, stocks, commodities, etc.) that users can access. This enables better customization and control of the user’s assets, i.e. the assets will be under the user’s control and no third party will have power over them.
What is a DeFi in crypto?
A DeFi in crypto is a service that uses smart contracts to enable the decentralized financial application (DeFi) model on a blockchain. There are several kinds of DeFi in crypto services that are currently available in the market. Exchanges – These are platforms that allow users to trade and exchange cryptocurrencies. The most popular platforms are Binance and Coinbase. Lending – Users can borrow money from lenders who provide them with fiat or crypto as a loan. P2P Trading – Users can buy or sell cryptocurrencies directly from each other through decentralized exchanges.
How do you make money with DeFi?
The idea behind DeFi is to make it easier to manage financial assets and make them more accessible and transparent. Therefore, anyone who offers a DeFi service will have their code made public on the blockchain. However, while they are public, they are also open to be updated and improved by other blockchain developers. The decentralized financial applications can be used by anyone who has access to the blockchain system. Users are able to use these applications to track their financial assets, make transactions, or even create new applications.
Current and future examples of DeFi
For example, there is EthLend that enables users to lend their cryptocurrencies to other users who can’t afford the interest rates of fiat loans. There is also Augur, a prediction platform where users can bet on future events, and earn money if they get it right. MakerDAO’s stablecoin DAI is another example of a DeFi that actually diversifies the risk of volatility in the crypto market. Other DeFi examples in the crypto space include Uniswap, a decentralized exchange; Oasis, a p2p trading platform; District0x, a p2p marketplace; EthLend, a decentralized lending platform; EthicHub, a p2p trading and tracking platform; EthicHub, a decentralized exchange; MakerDAO, a stablecoin; and Prycto.
How Defi Will Help Prevent the Next Financial Crisis
There are several reasons why decentralized finance might help prevent the next financial crisis, but some of the most important ones are: – Stability – With decentralized finance, the system will be more stable. No longer will banks be able to lend money to risky clients that might put the whole system at risk. – Transparency – No longer will banks be able to hide their financial information from the general public, which is essential for preventing the next financial crisis. – Accessibility – Decentralized finance will make it easier for individuals to access loans and credit. This way, people with poor credit will be able to get financing if they need it. – Liquidity – With decentralized finance, individuals will be able to buy and sell their financial assets whenever they need to, making it easier to cash out when needed.
How does DeFi challenge traditional banking?
Decentralized finance is expected to challenge traditional banking in several ways. First, decentralized finance doesn’t require a centralized institution in order to function. This means that it’s more efficient, cost-effective and accessible. Second, decentralized finance is essentially self-governing, which means that it doesn’t require a government or centralized regulatory body to regulate it. This means that it won’t have the same level of risk as traditional banking. Third, decentralized finance is completely transparent, which means that everyone can see the flow of money and transactions. This will make it easier for law enforcement agencies to track illegal activities. Finally, decentralized finance is powered by artificial intelligence (AI), which means that it’s self-learning and will be able to recognize patterns and make accurate predictions about the future.
Conclusion
Decentralized finance or decentralized finance is an exciting new way to use blockchain technology. While cryptocurrencies like Bitcoin rely on decentralized finance, other industries such as healthcare are also using blockchain technology to solve problems. Decentralized finance has the potential to be more stable than traditional finance, and could even prevent the next financial crisis.
