The bank of the future
“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.” ― Mark Twain
Decentralized finance, or defi for short, is the newest buzzword in the world of banking and economics. Many people are asking themselves — what exactly is defi?
We will explore this question by looking at how defi works, its benefits to society as a whole, and why it’s crucial to understand decentralized finance if you want to be part of the new economy.
What is Defi?
Decentralized finance is a term for Ethereum and blockchain applications that aim to disrupt financial intermediaries.
Decentralized finance, or DeFi, is a catch-all phrase for several cryptocurrencies and blockchain-based financial services to challenge financial intermediaries.
The “hub and spoke” architecture is widely used in today’s financial world.
Financial centers of activity, such as New York and London, serve as operational hubs for the financial services sector and have a significant influence on regional economic activity at spoke regional centers or financial powerhouses like Mumbai or Milan that may not be as global in importance as hubs but still function as nerve centers for their economies.
This is a multi-hub and multi-spoke model of global finance. This system of interconnectedness applies to the operation of international financial services firms as well. They have headquarters in major cities and regional branches, joint ventures, or investments across the world.
The organization’s spread across numerous financial jurisdictions renders it susceptible to a network of laws and regulations in each one. Such organizations have become systemically critical for the global economy’s equilibrium to be maintained and the creation or development of new financial services infrastructure.
In addition, central banks employ hundreds of people and incur high costs to provide services and products. Banks also have to rely on the legal system to resolve issues.
DeFi replaces workers and the legal system with Ethereum smart contracts on the blockchain, dramatically lowering operational expenses to provide goods that are often considered superior to traditional bank offerings.
Big businesses also have control over various transactions, including recurring or one-time purchases, contracts, or arrangements. Financial applications such as loans, insurance, crowdfunding, derivatives, betting, and more are all under their command.
One of the most significant benefits of DeFi is that it eliminates go-betweens from all kinds of transactions.
Defi is built on the Ethereum cryptocurrency
As the name implies, decentralized finance disrupts centralized models and allows financial services to be provided from anywhere in the world to anyone, regardless of race or age.
Most DeFi services and applications are based on public blockchains, and they either duplicate existing products based on established technology paradigms or offer unique services suited for the DeFi ecosystem.
Users’ money is also more secure because of the open architecture of DeFi apps, which allows them to retain full custody and control over their assets. Users may even trade currencies without intermediaries directly through personal wallets and trading services that cater specifically to individuals rather than institutions.
Most applications that claim to be “DeFi” are built on top of Ethereum, the world’s second-largest cryptocurrency platform, distinguishing itself from Bitcoin. It is easier to use to create different kinds of decentralized apps beyond simple transactions.
Solidity is one of the most common Ethereum programming languages, is designed especially for generating and deploying smart contracts.
For example, suppose a person wants money sent to a buddy the following Friday if it rains that day, according to weather.com. Such restrictions might be placed in a smart contract.
Dozens of DeFi apps are running on Ethereum, thanks to smart contracts at their heart.
The most popular types of DeFi applications
Decentralized exchanges (DEXs)
Exchanges allow people to trade currencies for other currencies. DEXs are a type of exchange that connects individuals directly, allowing them to trade cryptocurrencies with one another without having to trust an intermediary with their funds.
Pools are the new standard for creating a market. Uniswap, Kyber, and Balancer are all competing to become the most popular liquidity pool DEX.
Liquidity pools are funded by other users, who get paid the exchange fees for providing liquidity.
Lending markets are one type of DeFi that links borrowers to lenders of cryptocurrencies.
Users may borrow cryptocurrencies or offer their loans on one popular platform. Users can earn interest by lending out their funds. Compound sets the interest rates based on an algorithm; thus, if the demand for borrowing a cryptocurrency rises, the interest rates will also increase.
Lending through DeFi is collateral-based, which means to borrow money, you must give up collateral — usually ether, the cryptocurrency that powers Ethereum. Users don’t provide their personal information or credit score to get a loan like those with non-DeFi loans.
The stablecoin is another type of DeFi. Cryptocurrencies have greater volatility than fiat, which isn’t ideal for anybody wanting to know how much their money will be worth a week from now.
Stablecoins connect cryptocurrencies to other assets, such as the dollar, to combat volatility. Stablecoins aspire to provide price “stability,” as the name implies.
A “prediction market,” one of the oldest DeFi applications on Ethereum, is a so-called “prediction market,” where users wager on the outcome of an event such as “Will Donald Trump win the 2024 presidential election?”
The primary objective of the people who participate is, without a doubt, to make money. Prediction markets, on occasion, outperform conventional methods such as polling in predicting outcomes. Intrade and PredictIt are two well-known centralized prediction marketplaces with successful records in this area.
Defi can increase interest in prediction markets, which are traditionally frowned upon and frequently closed down when operated via a centralized approach.
How can I make money with DeFi?
The value locked up in Ethereum DeFi projects has been growing rapidly, with users reportedly utilizing Ethereum-based lending apps, as previously said. Users may produce “passive revenue” by loaning out their money and earning interest from the loans using Ethereum-based lending apps.
DApps are combining the internet with blockchain technology in new creative ways. Because you can stack dApps together to get the most out of them, DeFi is sometimes referred to as “Lego money.”
For example, you might buy a secure currency like DAI and then lend it on Compound to earn interest.
Future applications may have a significant impact on day-to-day life. You’ll probably be able to buy a piece of real estate or property under a DeFi mortgage arrangement, for example, where you repay the price in installments over time.
Is investing in DeFi safe?
No, it’s not. Many people think that DeFi is the future of finance and that early investment in this innovative technology may result in significant profits.
However, it’s tough for newbies to distinguish excellent projects from terrible ones. And there’s been a lot of awful in between.
The value of meme coin plummeted from $60 million to $0 in 35 minutes after the number of users and usage increased. Other DeFi initiatives like Hotdog and Pizza met the same end, and many investors lost money.
DeFi applications rely on smart contracts, computer programs that execute a set of instructions stored on the blockchain. However, if a developer’s code has an error, there may be flaws in a DeFi protocol.
Cryptocurrencies are subject to enormous price fluctuations because of their inherent volatility. The value of cryptocurrencies used as collateral may plummet dramatically if the market falls.
If you’re planning on investing in a DeFi solution, the first thing you should do is verify the ones you’re looking into to ensure that they are secure and well-audited.
“Big red flags” include “applications that don’t share their code or ignore concerns raised in their forums and social media platforms about security.”
The best projects are often run by nameless or pseudo-anonymous entrepreneurs who keep their privacy so that I won’t write a one-off. Still, I do expect transparency on the application. If something feels wrong, it’s probably because there’s something wrong.
DeFi, or decentralized finance, is a method of financial transaction that does not rely on intermediaries.
The decentralized finance ecosystem is still rife with infrastructure malfunctions and exploits. Scams are also common in the rapidly growing DeFi infrastructure. Hacker “rug pulls,” in which hackers drain a protocol of cash while investors cannot trade, are all too prevalent. However, well-established protocols may help minimize this danger considerably.
Given these concerns, it’s essential for people looking into defi products to do their research before investing any money at all. If you’re planning on investing in defi solutions, make sure to verify them first!
But DeFi has many benefits to offer consumers and companies alike.
It will allow for decentralized and crowd-sourced finance without third parties, which means there are no restrictions on what people can do with defi applications.
Another benefit that defi presents is that defi systems are open and transparent, which means people can easily view all of their transaction data. With traditional finance, there’s a lot more red tape involved in making changes to your account or getting information about specific transactions because companies may not share this information freely.
And because defi transactions are decentralized, defi applications can offer lower transaction fees to users, making it easier for people looking to make international payments or other types of transfers without paying a hefty price tag.
It indeed may be the bank of the future.