Decentralized finance (DeFi) relies on secure distributed ledgers, like cryptocurrencies. The system removes banks and institutions’ control over money, financial products, and financial services.
He says that some of the critical attractions of DeFi for many consumers are:
- The service eliminates the fees charged by banks and other financial institutions.
- Instead of keeping your money in a bank, you keep it in a secure digital wallet.
- Any internet user can access it.
- In a matter of seconds or minutes, funds can be transferred.
Arif Efendi helps in understanding decentralized finance (DeFi)
Understanding decentralized finance and how it works can help us understand how it differs from centralized financial systems.
The centralized finance system
Centralized finance involves banks and corporations that make money by holding their customers’ money. Third parties facilitate money movement between parties in the financial system, charging fees.
The merchant sends the charge to an acquiring bank, which then forwards it to the credit card company. Once the charge has been cleared, the network requests your bank for payment.
Through the acquiring bank, your bank sends the approval to the network, which then sends it to the merchant. Merchants pay for credit and with debit cards, so each entity in the chain receives payment for its services.
If all other financial transactions cost money, you might not even be able to use a bank if you’re traveling; loan applications can take days to approve.
Access to financial services and reducing transaction times are two of DeFi’s goals.
The decentralized finance system
People, merchants, and businesses can conduct financial transactions without intermediaries with decentralized finance. Peer-to-peer financial networks use security protocols, connectivity, software, and hardware.
You can use distributed financial databases to lend, trade, and borrow from anywhere you have an internet connection. Distributed databases collect and aggregate data from all users and use consensus mechanisms to verify it across various locations.
By utilizing this technology, decentralized finance eliminates centralized finance models by enabling anyone to use financial services wherever they are.
DeFi applications give users greater control over their money through personal wallets and trading services.
Decentralized finance does not guarantee anonymity despite taking control away from third parties. Although your name may not appear on transactions, those who have access to them can track them. Governments, law enforcement, or other entities may protect people’s financial interests.
DeFi: How Does It Work?
Cryptocurrencies use blockchain technology for decentralized finance. Blockchains are distributed and secure databases. To handle transactions and run a blockchain, there are applications called dApps.
The blockchain records transactions in blocks, which other users then verify. Upon agreement between the verifiers, the block is closed and encrypted; another block is created with the previous block’s information.
Blocks are “chained” together by the information in each subsequent block, which is why it is called a blockchain.
It is impossible to alter previous blocks without affecting the following blocks in a blockchain. Blockchains are secure thanks to this concept and other security protocols.
Financial Products from DeFi
DeFi’s core premise is peer-to-peer (P2P) financial transactions. P2P DeFi transactions occur when two parties exchange cryptocurrency for goods or services without involving a third party.
For a better understanding, consider how centralized finance works. Applying for one from your bank or another would require you to pay interest and service fees if approved.
Under DeFi, peer-to-peer lending does not mean there will be no interest or fees. Because the lender can be anywhere worldwide, you will have many more options.
DeFi’s app matches you with peers who can help you with your loan needs using an algorithm. Your loan would be approved if you agreed to one of the lender’s terms.
You receive your loan upon the blockchain’s consensus mechanism verifying the transaction. Once the lender has agreed upon a payment schedule, it can begin collecting payments from you. Pay via your dApp follows the same process in the blockchain; the lender receives the funds.
Currency based on DeFi
Cryptocurrency is used for transactions in DeFi. The exact implementation of existing cryptocurrencies is difficult to predict as technology develops. The concept focuses on stablecoins, backed by entities, or pegged to fiat currency.
The future of decentralized finance is still uncertain. It is unregulated, so the ecosystem remains riddled with infrastructural mishaps, hacks, and scams.
Separate financial jurisdictions, each with its laws and regulations, were the basis of the laws. The borderless nature of DeFi’s transactions raises essential regulatory questions.
When financial crimes cross borders, protocols, and DeFi apps, who is responsible for investigating them? How would the regulations be enforced, and who would carry them out?
The open and distributed nature of the decentralized finance ecosystem might also pose regulatory challenges.
There are also concerns regarding system stability, energy requirements, carbon footprint, upgrades, maintenance, and hardware failures.
Before DeFi is safe to use, there are still many questions to be answered and advancements to be made. At the very least, banks and corporations will find ways to use DeFi to make money if it fails.
What Does Decentralized Finance Do?
In all financial transactions, DeFi aims to eliminate third parties.
Bitcoin: Is it a decentralized finance system?
There is a cryptocurrency called Bitcoin. Bitcoin is not so much a part of DeFi as it is an integral component of its ecosystem.
How Much Value Is In DeFi?
In DeFi, total value locked (TVL) represents all cryptocurrencies staked, loaned, deposited, or used for other financial activities. The sum of specific cryptocurrencies can also represent economic activities, such as ether or bitcoin.
Platforms for lending
Cryptocurrency lending markets are a popular form of decentralized finance, connecting borrowers with lenders. Users can borrow cryptocurrencies or offer loans on one popular platform, Compound.
Borrowing money and earning interest is a way for users to make money. The Compound will set an algorithmically higher interest rate as cryptocurrency demand increases.
In the DeFi lending model, collateral is required for a loan, which is typically Ethereum tokens. Regular, non-DeFi loans require users to provide their identity and credit score to make a loan application.
Another form of DeFi is a stablecoin. Cryptocurrency’s price fluctuations aren’t suitable for people who want to know what their money will be worth in a week.
Cryptocurrencies are pegged to non-crypto currencies, such as the U.S. dollar, in stablecoins. Keeping with their name, stablecoins aim to provide price “stability.”
Notable stablecoins include:
- Tether (USDT)
- USD Coin (USDC)
- Binance USD (BUSD)
- Dai (DAI)
Hopefully, after Arif Efendi thoroughly explained the meaning DeFi, you can utilize this valuable information effectively to your finances.