DeFi – A business guide to understanding benefits, applications and risks
Decentralized finance is rapidly rising in popularity as a way to provide financial services outside of the traditional banking system. The adoption of blockchain technology in finance and the spread of decentralized financial services is shaping a new world called Decentralized Finance (DeFi). This world is characterized by global accessibility of financial services, safe transactions, low transaction prices, and the latest DeFi trends revolving in the market.
While decentralized finance (DeFi) has the potential to provide several benefits, it is also important to understand the risks involved before getting started. So, through this DeFi guide on decentralized finance development for businesses, we will walk you through the basics of decentralized finance, including what it is, how it works, and some of the major challenges you need to know before getting started. So without further ado, let’s get started.
What is decentralized finance – DeFi?
Decentralized finance or DeFi is a monetary system that is built on public blockchains. The components of open finance consist of protocols, digital assets, dApps (decentralized applications), and smart contracts, which are built on blockchain.
While many of us know Ethereum and Bitcoin as cryptocurrencies, very few of us know that they are open source, vast networks which allows users to develop apps that enable financial activity to brew centralized institutions’ involvement.
The introduction of decentralized finance has unlocked a world of new possibilities for users to interact with the Ethereum blockchain in ways that were not possible before. By using DeFi, users can lend or borrow Ethereum-based assets, earn interest on their crypto holdings, trade digital assets without having to use a centralized exchange, and much more.
The aim of introducing decentralized finance is to provide users with an alternative to traditional financial systems that are often opaque and inaccessible. By making financial services more accessible and user-friendly, it is hoped that DeFi will lead to a more inclusive financial system that works for everyone.
How does DeFi work?
Decentralized finance provides a way to access financial services without the need for centralized intermediaries. It uses smart contracts to enable peer-to-peer interactions on the Ethereum blockchain. There are two major components that allow a financial system to work effectively; the first is the infrastructure needed to operate on and the second is the currency that is needed to operate with.
Infrastructure – Ethereum is a DeFi platform used for writing decentralized programs. Through Ethereum, you can create smart contracts that can be used to establish a set of conditions or rules under which an agreement can be made. Once a smart contract has been deployed, it cannot be altered.
Currency – In order to create a secure, reliable decentralized finance system, a cryptocurrency is needed that can be used to interact with the various protocols. Generally, DeFi uses the DAI stablecoin as its currency. DAI is a decentralized stablecoin that is pegged against the US Dollar.
Now that we know what is DeFi and how does DeFi works, let’s have a comparative look at DeFi vs traditional financial system in our (decentralized finance) DeFi guide.
Traditional Finance vs Decentralized Finance
While Decentralized Finance (DeFi) is only an advanced version of the finance structure with the same core working, lying in receiving and giving money, there are some inherent decentralized differences to consider for distinguishing between DeFi and fintech. The one that makes blockchain application development company one of the key fintech trends for 2021 2022 and beyond. So, let’s move further to know the differences.
Operations of DeFi are not managed by institutions and employees. Their role is played by algorithms written in code or via smart contracts in the DeFi environment. Once a smart contract is deployed to the blockchain, DeFi apps run without any human intervention whereas in traditional finance, there are intermediaries like banks that manage the financial operations.
One of the prominent DeFi features that clearly defines the differences between DeFi and traditional banking apps is that the former comes with the power of code transparency. This makes it possible for anyone to audit, which develops a trust with users because everyone has the opportunity of understanding the contract’s functionality. And since the transactions are pseudonymous, the privacy questions never emerge. However in traditional finance, the monetary operations are managed by intermediaries so security breaches may arise.
dApps development, another type of blockchain application used in the DeFi environment, has been designed to act globally from day one. Irrespective of which geographic location you belong to, the access to DeFi networks and services are the same.Whereas in case of traditional finance system , the services offered by financial institutions are restricted to their localities. For instance, you can only open a bank account in the country where the bank operates
Anybody can create decentralized finance applications and use them. Unlike present–day finance, there are no accounts or gatekeepers on this front and the users interact directly with smart contracts from DeFi crypto wallets.
The new decentralized finance applications are built and composed by mixing other DeFi products like in the case of Lego. For example, decentralized exchanges, stablecoins, and the prediction markets can be mixed to develop new products. However in traditional finance system, the applications are single-purposed and each one of them is created for a specific task.
Benefits of DeFi
Traditional banks are administrative in nature and expensive to run. The process for transactions takes time and has removed numerous individuals out of the financial framework because of their rigid rules and requirements. . DeFi came to settle a large number of these issues. Some of its key benefits are listed below:
One of the key benefits of decentralized finance (DeFi) is that it is permissionless. This means that anyone can access DeFi applications and services without having to obtain approval from a centralized authority. This openness and accessibility are few of the main attractions of DeFi, as it allows anyone with an internet connection to participate in the thriving ecosystem.
In addition, permission-less DeFi platforms are often more secure than their centralized counterparts, as they are not vulnerable to single points of failure. This makes them ideal for storing value and participating in financial transactions. Consequently, the permissionless nature of DeFi is a major selling point for those looking to get involved in the world of decentralized finance.
With decentralized accounts, developers can freely expand on top of existing protocols, customize interfaces, and integrate third-party apps. Because of this sort of adaptability, DeFi conventions are often known as ‘Money Legos.’ New decentralized money applications can be built by consolidating other DeFi products.
For instance, stablecoins, decentralized trades, and forecast markets can be joined to frame a completely new and significantly more progressed DeFi finance market size and centers.
DeFi empowers a more prominent degree of openness and accessibility. Since most DeFi protocols are based on the blockchain — a public ledger — all exercises are available to the general population. Anybody can see transactions, however, these records are not attached to anybody directly just like the case with traditional banks.
All things considered, accounts are pseudo-anonymous, posting only numerical addresses. Users with programming information can likewise access most DeFi products’ source code to review or build upon since they’re open source. Open-source codes are safer and of better quality than proprietary software, on account of local area connection.
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