The world is changing fast and it also allows us to morph into a different kind of trader and investor. Cryptocurrencies have allowed us to upgrade our finances without the hassle of intermediaries or middle men with the help of decentralized finance or DeFi.
Cryptocurrencies have been around for over ten years. They allow us to digitally transfer money and assets across the world without any intermediaries such as banks to process transactions.
Cryptocurrencies have inspired many other significant innovations, such as Smart Contracts or ICOs. Decentralized Finance (DeFi) is the latest product of the cryptocurrency world that has the potential to change the financial system forever. Let’s find out what Decentralized Finance (DeFi) is and how it can impact your life.
Exploring Decentralized Finance (DeFi)?
Decentralized Finance (DeFi) is the new financial system that allows financial transactions such as transferring money, getting a mortgage, loaning, or earning interest to be done without any intermediaries like banks.
Financial transactions usually rely on trust. If you want to lend money to someone, you need to trust that you would get the money back; this is where the bank comes in. Banks, or any intermediaries, came in to be the trusted party.
You deposit money in your account and earn interest, while banks loan your money to earn interest. Although it’s similar to you lending money to someone directly, banks have processing costs and risks of not getting paid back, so they take some of the profits that you could have earned without an intermediary.
Decentralized Finance (DeFi) uses digital technology such as Smart Contracts on Blockchain instead of banks as a trust factor in processing financial transactions. Blockchain-based technology like DeFi is transparent and checkable.
Decentralized Finance (DeFi) also allows us to continue using the financial products without high fees and the slow processing time of the middle party.
What is Centralized Finance?
When you think of banks and financial institutions, this defines centralized finance. It’s the all-too-familiar route to save, lend, borrow, and invest money. It’s all about intermediary control over people’s money or assets.
Centralized finance is the financial system that we are all familiar with. Almost every aspect of banking, lending and trading is managed by centralized systems.
This centralized system offers a high level of trust since other people are subsidizing your risk. When things go wrong, it might take a shorter time to fix the problems since you know who’s in charge.
But centralized finance systems come with their challenges. In the event where the entity who is in charge has an issue and the whole system stops, you won’t be able to do anything. Just like when the bank application crashes or the system is hacked.
Centralized finances often slow things down and cost much more than they should without offering any transparency to your money management. The central bank can ease or tighten the money supply as much as they want without us having any control, while a decentralized system provides more transparency and equality.
Advantages of Using DeFi
Decentralized Finance (DeFi) is unique and has the potential to disrupt the financial market. Let’s see how it can be life-changing for you and your finances.
Speedy and Affordable Transactions
Most financial transactions require an intermediary. If you want to transfer money from the United States to anywhere in Asia, you need an intermediary like a local bank or financial entities like Westen Union or Wise to help process the transactions. You then need to pay for operational costs.
On the other hand, if you transfer money through online transactions without any intermediaries, you can avoid the costs and frustrating processes altogether.
Accessibility for the Unbanked
The world may not be fair for everyone which is clearly shown as some people are denied access to banks and other financial companies. Some unbanked people cannot benefit from the financial products as we all do.
For instance, without a good credit rating or history, people cannot get a loan to expand their businesses. Some can’t even open a bank account to store their money there. DeFi allows anyone to access the service from every corner of the world by just having a cell phone and internet access.
There is a clear advantage with the digitized makeup of decentralized finance. Process is online which means you can gain access to your money fast and without waiting for days or weeks for approval.
Back in the day, you might need to wait for months to get a business loan. If you are an artist, you might need to wait for an exhibition to sell your paintings.
With DeFi, anyone can tokenize any asset and sell them digitally. No more complicated and expensive payment gateways or processes. Fundraising, loans, and payments are also easy, there are fewer barriers to starting new businesses, especially international ones.
The world eats and breathes online transitions. That is why DeFi thrives today as one option that frees people from boundaries. DeFi allows financial transactions to take place online, similar to financial applications, making people enter the world of DeFi with less hesitation.
Lend and Borrow Money Fast
People traditionally store money or assets in bank. However, you get to earn very little interest while banks use your money to make more money, such as giving loans to people and earning high interest.
Instead of leaving your money with banks, you can lend your money directly with DeFi by using digital assets such as Bitcoin. This means you can receive the entire profit from interest without paying processing fees or risk fees to banks.
Use Stablecoins to Decrease Fluctuations
It’s common knowledge that digital currencies such as Bitcoin fluctuate, making it hard to use them in daily life, but stablecoin do not.
A stablecoin is pegged to an underlying asset, such as gold or forex reserves which act as collateral. their valuations remain free from wild swings. One of the good examples of a Stablecoin is USDT, where every token is worth 1 USD.
Besides less fluctuation, stablecoins allows users to create virtual assets on DeFi. You can use any token as collateral, which means you can digitally sell any real-life assets like dollars, golds, real estates, or stocks.
Raise Funds with Security Token Framework
You would normally put more value in the real or physical world that digitally, so it’s almost impossible to have as many digital assets as there are physical ones.
Due to that fact, people developed frameworks to tokenize financial assets like bonds or stock. Under authorized supervision, you can now digitally/virtually raise funds easier than before instead of going through time-consuming processes like IPOs.
With the test of time, we might see that people would prefer the digital ways over the old ways.
DeFi and Smart Contracts
A smart contract is a set of conditions that any developer can write to put in a digital contract. For example, you buy a home-assistive device from Brett.
In that case, your payment will then be completed as soon the device is shipped, and Brett will receive it automatically. You don’t need to worry about paying in advance and not receiving your order.
On the flipside, Brett also has peace of mind since he knows he will get the payment. Everything on the contract is on the Blockchain, which can’t be changed.
A smart contract allows DeFi to process financial transactions such as deposits, withdrawals, and even allows contract parties to use collateral.
Smart contracts bring more liquidity to certain markets as it allows users to buy and sell tokenized stocks or fractions of collateral, increasing the capital pool.
Decentralized Exchanges usually use Smart Contracts, so they don’t need an intermediary. This is why you need to read the contract before you give it your green light.
The Tandem of DeFi and Ethereum
Decentralized Finance has no intermediary, so we need Smart Contracts to help process automated transactions such as paying for fees or creating tokens. Majority of DeFi is on the Ethereum Blockchain due to its simplicity and popularity among developers.
There’s no doubt that a higher adoption rate of Decentralized Finance results in a higher price for ETH. Since 2020, more people have been using DeFi, and the price of ETH has been rising, even more than BTC, due to its real utility that is more than just payments.
Is Decentralized Finance (DeFi) Too Complicated?
DeFi is still in its very early days and it is complicated for a lot of non-tech savvy people. Some transactions are unique.
Investing in DeFi requires deep research, same with any other technologies that evolve fast. Prices of DeFi tokens also increase a lot in a short time.
High volatility means a high risk of investment. So make sure you do your research before putting any money in the game.
Decentralized Finance (DeFi) used to be seen as something that could only work far into the future. However, we have seen more adoption and use cases in the real world, showing that problems are waiting to be solved by DeFi.
It’s exciting to see how DeFi can offer better financial products for everyone. The possibilities are limitless; from higher interest rates than your traditional saving accounts, to a simple way to raise funds for your business, and much more.
While it may be too complicated or technical for some, understanding DeFi is simple and practical than settling for what you are used to when you focus on understanding how it can turn the tables around for your life and finances NOW.