DeFi or Decentralized Finance is one of the buzz words in the finance sector today. DeFi and the open finance movement are gaining in popularity among investors. This is why it is important to understand what it means.
What is Decentralized Finance?
Decentralized Finance is the use of decentralized applications and smart contracts built on decentralized networks by making use of blockchain technology. Ethereum is an example of a network built using DeFi protocols. DeFi platforms are used in cryptocurrency, tokenising assets like gold, derivatives, payment networks, borrowing & lending, decentralized networks, and insurance.
The key elements in DeFi are:
Smart contracts
This is what makes a system like Ethereum unique. It allows scripts or applications running on the network to create digital assets. This ensures an irreversible agreement for payment and transfer. The need of a middle man is thus eliminated. Two unknown parties can carry out a transaction thanks to the use of smart contracts.
DApps or Decentralized Apps
DApps are software applications running on a distributed network that is peer-to-peer connected. This differs from other networks that have a central server. They work just like any app, but the difference is that it runs on a decentralized network.
DEX or Decentralized Exchange
Decentralized exchanges are similar to online trading platforms like eToro. The difference is that the decentralized exchange runs through smart contracts and uses the blockchain. Investing in cryptoassets is possible with the decentralized exchange.
The Benefits
There are numerous benefits that DeFi offer for the financial sector and for consumers.
- The chances of human error are virtually eliminated. Smart contracts run the transactions and hence chances of errors are reduced. The DApp can run without any human intervention making it a fool-proof system.
- DeFi allows users a flexible experience. Anyone can build or modify DeFi, which is why most projects are open-source. The collaborative nature has allowed a strong community to grow, which would lead to more innovations that would benefit all stakeholders.
- DeFi can be accessed at any time and at any place. There are no restrictions on borders thanks to the distributed network being used. All that is required is internet connectivity. Of course, any local laws would govern the usage of DeFi.
There are a few drawbacks to DeFi, but these are not major:
- Transaction speed is slower because the blockchain is decentralized.
- All responsibility is on the user and any mistake committed can be very costly.
- It is a new technology that requires time and effort to adopt.
The article has been published by the editorial board of the Fintek Diary. Happy Reading. For more information please visit www.fintekdiary.com
