What is DeFi and How it works?
So by now, we all have encountered the word “blockchain”, let us try linking it to the world of finance that runs in the system of intermediaries to provide us with all the exclusive services till now. When we add financial services to our lives with the help of blockchain technology, it becomes easier to access personal financing derivatives at all times.
Decentralized finance (DeFi) is a term used for a complete digitalized system of financial transactions that occurs by the means of blockchain technology and eliminating the middlemen’s requirements for availing the financial products.
The system is free from any central authority control and engagement of intermediaries, therefore working on the base of peer to peer transaction that is recorded in ledger formats, with clear and transparent information systems. The users of this technology can access the framework with the help of decentralized apps and use their assets according to their will at any point in time.
The DeFi systems work on tokens and codes that enable having separate user ids and facilitates all the services like lending, borrowing, insurance and asset management. In light of no physical mortgaging system, measures to eliminate this gap have also been created. Using stable coins that can define the value of mortgages and can be digitally transferred through the technology are undergoing the process of creation to make the transaction more easy and available to all. The fact that there is no restriction on entry and exit of any individual. Makes it more engaging for users to rely on these decentralized systems of finance.
DeFi can be seen as an emerging option for creating and managing financial services among users and creators, this is evident as even having an early market the valuation locked in DeFi contracts stands at $41 billion up till March 2021.
How DeFi is different from traditional methods of finance?
The major difference between traditional sources of financial services like banking, wallets, card systems etc. and DeFi is the involvement of intermediaries and authorities for control. The ease of access and time-saving technology make the user interface easy and appropriate for any number of users to enter the financial marketplace or exit at any time without any prior procedures or income statements verifications.
Borrowing and lending
Traditional system – In the traditional system of financial services, the borrowing and lending capacities are in the hand of regulators and intermediaries like banks and governments. The cost of borrowing is not only the interest paid but also the cost occurring from regulatory compliances as well as for lengthy procedural process for seeking applications.
DeFi system – In the case of a decentralized financial system, the apps used for the process of lending and borrowing facilitate direct contact with any interference of any third party in the procedure. This reduces the time and cost of delays and helps in creating stable capacities according to the user’s will.
Banking and allied services
Traditional system – traditionally the banking services of insurance, money creation and others are carried out by the means of technologies with banks and not the end-users. the banks provide these facilities with high fees and complicated processes. the credit creation and finance services are relegated by higher official rulebooks.
DeFi system – this system allows the individuals to work for themselves without incurring much hassle procedure and cost of maintenance. Just having apps with blockchain facilities and the internet will make you eligible for making payments by the use of assets or cryptocurrencies which eliminates the use of money directly. The insurance deals would also use the codes and hence be transparent in every manner.
Trading and investment
Traditional system – the general trading systems happen in stock markets, commodity markets with linking income sources to separate accounts and then using that income to buy or sell securities under the eye of regulators. the investment securities do not create digital assets by the means of blockchain technologies but use simple intermediaries to facilitate trading in assets.
DeFi system – asset creation on DeFi is the best use of this system as it enables the users to rade in digital assets like cryptocurrencies and invests in the same without any regulatory framework and taxation compliances. No intermediaries just the amount transferred to blockchain-enabled user interface and here you go with managing your asset trading.
Here is a pictorial representation of different apps in both the systems that enable financial services but use different technologies to distinguish traditional and DeFi services.
Why it can be disruptive for traditional finance?
- The ease of access – the ease of transaction with automated codes, any point entry exits and no intermediaries are the features of DeFi that make it more reliable for the user to access financial services and shift from traditional source to the modern tech-based one.
- Cost-effective – with the least cost of finding services and accessing them, the blockchain requires just the service amount and internet facilities that cost the minimum in comparison to old infrastructure-based financial systems. Not just this but it also enables low-income groups to enter the financial framework due to low cost and therefore encouraging more people to switch the methods of traditional finance.
- Ease from lengthy procedures and regulations – since there is no regulatory mechanism and all the procedures are under a decentralized technology, the evolving technology paves a way for financial market users to jump into the DeFi systems for better allocation of resources with minimum delays.
- Transaction transparency and minimal loopholes – being free from any interference, and using a direct non-manipulative technology enables DeFi to make transactions more transparent than the traditional systems and combines the factor of minimum loopholes in absence of institutional frameworks.
- Absence of bais – The bais in the traditional system of finance creates an advantageous situation for big firms and exercise high power of individuals and political controls, whereas, in the DeFi system, the equality remains on top with standard operating norms same for everyone, the computerized mechanism initiates the minimum and maximum points same for everyone regardless of who is the user. This makes DeFi more reliable and relevant in comparison to traditional systems.
This complete digitalization is going to takeaways the prosperity locked in traditional finance and certainly enhance the user experience by making attractive models of finance technology in the future.
