If you follow crypto news, you may have heard about the term DeFi. In this article, I will explain DeFi in a simple and easy-to-understand manner.
What is DeFi?
DeFi is the short form of Decentralized Finance. DeFi is an open alternative to the current financial system we have. It is basically a term used for peer-to-peer financial services based on blockchains. You can do most of the things such as earn interest, lend, trade, and more but without any need for the paperwork or a third party
The financial system we use is centralized where banks control everything. This system is also full of third parties who charge commission. In the current financial system, banks keep your money and charge for using their services. You need to follow the paperwork for opening the bank account and for requesting other services. The fund transfer is also not instant in most cases. Loan approval also takes a few days to be approved.
DeFi is consumer-centric because there are no fees and you hold your money in your secure digital wallet. Anyone with an Internet connection can use the services without needing any approval. Your fund transfer also takes a few seconds. DeFi uses security protocols, connectivity, software, and hardware advancements to offer peer-to-peer financial services.
DeFi uses blockchain technology used by cryptocurrencies. Blockchain is a distributed database. All the transactions are recorded in blocks and then verified by other users. If the transaction is verified, the block is closed and another block is created that has information about the previous block.
In Blockchain, blocks are chained together. Hence it is called Blockchain. Information of a previous block cannot be changed without affecting the following blocks. This is the reason there is no way to change the information In the blockchain.
DeFi requires Stablecoins because it needs a stable and reliable base value. Stable coins are tied to a fiat currency or to the price of a commodity. So, it offers price stability by maintaining reserve assets as collateral.
DeFi is growing and its market has already grown into a multi-billion dollar industry. As of January 2022m it has a market value of $90 billion. With the growth, new DeFi protocols will be created as per market need.
Decentralized finance or DeFi is still in its early stages. It is also unregulated with a few of the consumer protections that we have in the current financial system. If you take a look at the technology, the project has potential to revolutionize the financial system. There are already several companies that have started using DeFi protocols. So, it will be interesting to see DeFi becomes a mainstream product.
DeFi platforms run on open-source smart contracts. So hackers can probe these network to find vulnerabilities and then use the vulnerabilities to perform hack and scams. Last year in July, DeFI platform Poly Network was hacked and hackers stole $613 million in digital coins. So, there must be a tight security protocols. Users also need to be educated on how to keep their digital currency safe in a digital wallet.