What is DeFi?
DeFi means Decentralized finance. This means that it is a different financial system from traditional banks. It uses open-source technology, uses no permissions or access controls, and aims to be a fully transparent, app-based financial services ecosystem that uses public blockchain networks. By using these networks, DeFi can create new financial markets, products and services.
Why is DeFi a good option – and for whom?
In case you’re isolated from traditional financial systems, with their gatekeepers in the form of old-school banking behemoths, DeFi is a way to circumvent these hurdles and still get the funding you need – while still remaining entirely in law.
DeFi applications do not use intermediaries, gatekeepers or arbiters. As a user, you retain full control of your assets at all times. Any potential issues or conflicts are resolved by specifications in the blockchain networks code, which means that all resolutions are quick, drama-free, and relatively straightforward. It also means that you don’t pay traditional banks their traditional fees to be able to live, breathe and trade.
If you’re an SMB startup, DeFi can make it easier for you by removing not only the fees, but also the levels of scrutiny bureaucracy of traditional banking. Traditional banking systems imply that everyone in the chain between you and your assets makes a profit. As such, they make it harder than it should be to raise funds when you need them and to raise as much as you need them. Low-income communities are prevented from accessing the kind of traditional banking services they need to build successful startups and businesses.
With DeFi, these restrictions don’t exist, so low-income communities can get the funding – and services – they need through the application of technology to finance.
Why can I use DeFi?
You can use DeFi for a wide range of financial functions.
Standard loans and borrowings
It sounds obvious, but one of the main reasons people use financial products is to raise money by borrowing. This is also true in DeFi. Of particular use in DeFi, there is no credit check for your borrowing – which, again, can be extremely helpful for people looking to start businesses in low credit areas, or if they personally have a bad credit history that prevents them from using traditional banks to obtain the capital they need.
You can also get instant settlement of transactions through DeFi, which is useful if your business exists from paycheck to paycheck.
In case this sounds like a risky madhouse, it’s worth remembering that the system is backed by cryptographic verification methods. Much more is put in the hands of relatively foolproof and incorruptible systems, so you can do more with less overt human involvement or control.
Naturally, you can use DeFi to provide technological equivalents of standard banking services. Mortgages, insurance, issuing stablecoins (or cash, as it is also sometimes called) are all available through DeFi. Stablecoins are technically crypto-assets, but they are pegged to real-world assets. Stablecoins are just an easy way to transfer the value of real-world assets, so obviously stablecoin collateral for things like mortgages is tied to real-world assets, but with DeFi the whole process Using these assets as security, for example, is becoming a lot more streamlined by technology and by eliminating traditional banking middle managers.
By using smart contracts (contracts that are essentially pieces of computer code that automatically govern the behavior of resources), the entire process of standard banking can be sped up and made simpler than the long, often complex, often heartbreaking . and a hassle-free experience that it can be in traditional banking structures.
Similarly, getting insurance on the blockchain allows for a much wider spread of risk. And the wider you can spread your risk, the lower your premiums should be.
Decentralized exchanges allow you to trade digital assets without the need for a trusted human intermediary. Transactions are made directly between the buyer’s and seller’s users’ wallets, and they are made quick and easy through the use of smart contracts.
Again, decentralized exchanges offer the benefits of simplicity and speed, but also allow you to buy and sell with significantly lower transaction fees than you would have accrued if you used banks or traditional exchanges. .
Because you’re using blockchain technology, you can still use traditional financial instruments, but like every other use of DeFi so far, you’re eliminating custodians, custodians — and at least most fees.
If your business involves staking, reward pools, and other interest-bearing products, DeFi allows you to maximize the returns you can earn from these activities. For example, if you’re a bitcoin miner, you can use a smart contract to take all the rewards you reap and invest them in more of your underlying asset, almost automating the cycle for you, without you have to tediously move assets from place to place and both wait and pay for the lien, as you would in traditional banks and markets.
Is DeFi safe?
Arguably, DeFi is the application of new technology to an old problem, and the solutions it creates are actually more secure than those that exist with traditional banks.
DeFi financial services are built on blockchains. The data of any transaction is recorded on the blockchain and spread over thousands of nodes. This means that it is much more difficult to design a single point of failure, such as a potential service outage, than it would be in traditional banking systems, which often focus on single physical locations, or on systems located centrally.
That said, there are some things to understand before jumping into DeFi with both feet.
While in traditional banking, you have the security of a banking institution and its diversified risk portfolio behind you, if you take out crypto loans, you are banking on the counterparty faithfully repaying its debt. There is a risk that they will not, in which case you may lose your assets.
The legality of services can be difficult to determine, so if you invest in a smart contract and it is closed as illegal or suspicious, your assets can either be frozen indefinitely or lost for good.
When the assets you hold have different levels of risk associated with them – which they will have, in the same way that a portfolio of stocks will contain stocks with different levels of risk – you risk a token devaluation or crash. .
Where you may be more vulnerable with DeFi than with traditional banking is in the area of code vulnerabilities. Such vulnerabilities can weaken the security of your smart contracts and expose you to more risk than expected. You can also compromise your wallet in some cases by granting too many permissions to DeFi apps.
So, should I use DeFi or not?
Yes. And no. If you struggle with traditional banking and financial services, need to bypass the bureaucracy of traditional infrastructure, or want faster banking with fewer credit checks and lower fees, then DeFi has something for you. to offer. It’s not, and shouldn’t be treated as a tech-banking panacea for anyone with crazy ideas and nothing else, but it can offer distinct benefits of higher speed, greater security , lower fees and less bureaucracy than many centralized financial structures.