DeFi is a buzzword you'll likely hear more of in 2022. Decentralized finance (DeFi) refers to applications built on public blockchains that provide financial services without centralized intermediary.
Guess what? This new financial system is built on secure distributed ledgers, similar to those used by cryptocurrencies.
Several platforms are leveraging this technology to allow consumers to lend or borrow money from others, trade cryptocurrencies, hedge against risk, and earn interest from savings accounts.
As you might have guessed, it's called Defi:
We will learn about the decentralized financial system in this article, including how it works and how it works in the IT world.
What is Decentralized Finance (DeFi)?
Enabling individuals, merchants and businesses to conduct financial transactions using emerging technologies, decentralized finance cuts out the middlemen.
The peer-to-peer financial network uses the security protocols, connectivity, software development and hardware used to achieve this.
Simply put, if User wants to borrow $55,000, User must have assets or money in the bank as collateral. The bank manager (user ?) evaluates your finances, then the lender (user) sets the interest rate on your loan repayment based on the bank's requirements.
The bank lends you money from its deposits, collects your interest payments and reserves the right to take your collateral if you fail to pay. The same goes for stock trading, wealth management, insurance, and most other types of financial services available today.
On the other hand, decentralized finance (DeFi) is reinventing financial services in the form of decentralized software applications that run without ever taking ownership of customer funds.
How does Decentralized Finance (DeFi) work?
Decentralized finance uses the same blockchain technology used in cryptocurrencies. Blockchain is a secure and distributed ledger or database.
A Smart Contract is an Ethereum account that can hold funds and deposit/repurchase them based on predefined criteria. A smart contract in DeFi will replace the financial institution in the transaction. No one can modify the smart contract after it is live; it will still work as programmed.
For example, a allowance distribution contract could be coded to transfer funds from account Y to account Z only if account Y has the required amount.
Rewards and Risks of Decentralized Finance (DeFi)
DeFi's operations are based on open source software and can be virtualized and customized.
DeFi blurs the line between the average customer and wealthy individuals or institutions with access to a wider range of financial products. Anyone can join a DeFi lending pool and lend money to others, which means anyone can lend money.
Depending on whether the existing pool of collateral offers the best return on your investment profile, funds may automatically switch between you. As a result, rapid innovation in e-commerce and social media could become the norm in traditionally conservative financial institutions.
During Q2 2021, over $83 billion in cryptocurrencies were locked in DeFi contracts Read more about rewards, volume, and returns here
DeFi has the potential to amplify volatility the inherently high volatility of cryptocurrencies. Many DeFi systems allow investors to use leverage, allowing them to borrow money to increase profits but also increase the risk of losing money.
Since the DeFi industry started gaining traction, there have been a number of hacks. About $300 million was stolen Read More. Many of them are due to errors in the coding of smart contracts, which puts the DeFi ecosystem at risk.
The following section compares and contrasts the current centralized financial system with the decentralized financial system.
Centralized vs Decentralized Finance
Your money is held by banks, corporations whose main goal is to make money through centralized finance. Third parties facilitate the flow of money between parties