Decentralized finance (DeFi) is a financial ecosystem consisting of digital assets, smart contracts, protocols, and dApps built on a blockchain network. The aim of creating this ecosystem is to have an open-source, permissionless, and transparent financial system which is not governed by any central authority. It allows users to enjoy complete control over their assets. They can interact with each through peer-to-peer (P2P) networks and decentralized apps (dApps). There are several blockchain platforms that provide DeFi applications, but Ethereum is the choice of the majority. The dApps applications can be modified and integrated as per the users’ needs. Some of the popular DeFi products are decentralized exchanges, lending & borrowing markets, payment networks, and tokenized physical assets. DeFi has the potential to create a new order of financial markets and products in the future.
The Difference Between dApps and Traditional Apps
Unlike traditional apps, dApps are decentralized and are not controlled by an organization. The major advantage here is the functionality of dApps is not restricted to any geographical boundaries and anyone with an internet connection can access them. They rely on computer codes used to create smart contracts. These smart contracts run on the blockchain network without any sort of human interference and at regular intervals, developers update the dApps and fix the bug issues. The dApps codes are transparent in nature and provide the scope to the community members to understand the terms & conditions of smart contracts. All the transactions are public but don’t compromise on privacy as it’s not directly linked to anyone’s identity. Another advantage of dApps compared to the traditional apps is, they don’t require permission from any regulatory bodies which makes it less complicated and more flexible to use.
The Popular DeFi Products
The cryptocurrencies which are pegged to other assets to secure the stability is known as stablecoins. In the traditional world, fiat currencies, and assets have a stable price. Stablecoins act as a liaison between the traditional world and blockchain industry. They also help in enjoying the benefits of cryptocurrencies by controlling the side effects of volatility. Stablecoins are generally backed by the USD or gold, but in theory it can be backed by any fiat currency or asset. The stablecoin project ‘Maker’ is a part of the DeFi movement. Each stablecoin is known as Dai and the Maker Oasis dApp allows anyone to create their own DAI stablecoin. It also gives the voting right to a person who holds a separate MKR token on important matters like stability fee. The decentralized finance movement is dominated by the project Maker as it contributes to more than 50% of the DeFi sector.
Borrowing & Lending
It’s one of the most popular DeFi products as borrowing and lending under traditional financing methods is quite a painful experience. There are a lot of documentation processes like eligibility certificates, collateral security, and checking the financial background to see whether the borrower has the capacity to repay the loan amount under the set EMI tenure. Whereas decentralized lending and borrowing have many advantages like instant settlement, provision of showing digital assets as collateral security, and no credit score check required. The transparency of these services is on a higher side as they are built on a public blockchain. Also, this service reduces the counterparty risk, is more cost-efficient, and has a faster process rate.
The Advantages of DeFi
The main advantage of DeFi is indeed the hassle-free experience that it provides to the traders. The traditional financial services have a set of governing bodies and institutions to look after the whole process. It includes services from the banks and courts in case of a financial dispute. DeFi applications don’t have such regulatory bodies which enables them to provide such services at an economical rate. All the DeFi products are built on a blockchain network that avoids the scope of a single point of failure. The codes written in smart contracts resolves the concern of financial disputes. It also lowers the censorship as the data recorded on the blockchain network is spread across huge numbers of nodes globally.
The Disadvantages of DeFi
The decentralized nature of blockchain technology is relatively slower than the centralized networks. This aspect applies to DeFi products as well. The makers need to take this into consideration and enhance their products accordingly. DeFi applications don’t have a user-friendly interface that ends up giving a bad user experience. It should provide services with ease that enables users to have a smooth transition from the traditional finance system. There’s a huge risk factor as the accountability is taken care of by the centralized institution is transferred to the users’. This can put many users in a dilemma about the security features and the scope of errors will be reasonably high. Also, the platforms providing DeFi services are vulnerable to cyber-attacks. The security of users’ funds in such a scenario is a matter of concern. For instance, the DeFi platform dForce lost $25 Million in Bitcoin and Ethereum on April 18, 2020.
DeFi is still in nascent stages and has the potential to disrupt the traditional financial system in a big way. The whole movement will create a revolution in the financial market and generate a system of less censorship. The makers need to find more use cases and evolve the system to suit the characteristics of the blockchain network. In the future, if DeFi’s challenges are addressed properly, then its success would take away the power of centralized institutions. This may or may not create an excellent financial system that can only be analyzed once DeFi as a system is adopted by mainstream users’.