DeFi: the Future of Decentralized Finance
DeFi: the Future of Decentralized Finance
In 2021, more and more of us are looking for ways to dissociate ourselves from institutional systems. The democratization of blockchain, smart contracts and the emergence of neo-banks have made us realize that tomorrow will be about innovation and transparency.
Added to that the expensive costs, the slowness of execution or the lack of transparency only confirm this desire to free themselves from “traditional” banks. The DeFi, acronym of “Decentralized Finance”, has thus made its appearance and starts to interest investors and individuals. In this article, we will discover why DeFi could become the new financial hope.
Definition of DeFi
Decentralized finance or DeFi takes up the concepts of current finance such as bank loans and exchanges, borrowing, insurance and the stock market. These systems, on which finance is based, have been aggregated with the world of blockchain and decentralization; they thus evolve in an environment free of institutional or commercial intermediaries defining its own rules, without any conditions.
For example, buy and sell orders on the stock market take place without a middleman such as a bank imposing its own fees and conditions, or the insurance field acting without a legal entity deciding and imposing its own rules.
As you may have understood, DeFi works on a peer-to-peer basis, thanks to the blockchain. It ensures the relationship between third parties. Based on an automated algorithm, the blockchain defines transparent rules in complete autonomy.
From this innovative technological concept, decentralizing finance offers a field of possibilities to many products and services related to this sector.
Which financial services and products are decentralized?
We mentioned them in the first part, let’s explain these categories in this decentralized system.
The DeFi technology will allow each person who owns cryptocurrency, to be able to block it in a smart contract. For example, a person who locks 100 tokens, or coins, into a contract will be able to borrow 25% of that amount in real currency.
This is for investors and people who own dedicated cryptocurrency and do not want to trade it. The loan representing a quarter of the allocated value, may seem low but allows to maintain a structural relationship of trust. Indeed, operating in a completely digital way, the system must ensure the reliability of its participants.
The approach is interesting if the placed cryptocurrencies continue to increase in value. This system thus allows to create a stable value backed by euros or dollars while remaining in decentralized finance.
- Lending and borrowing
This concept is similar to the previous one. Indeed, when an investor blocks cryptocurrencies, a marketplace is created. By lending a defined amount of money on the blockchain, people will come and borrow it and pay it back with interest.
During these interactions, the blockchain makes sure to adjust the “collateral ratio” to ensure security between the lender and borrower.
This category is for anyone who wants to (still) trade precious metals or stocks via blockchain. A significant advantage that opens up market opportunities and allows for more important trading strategies.
This concept is quite particular because, thanks to the blockchain technology, cryptocurrency holders can insure their capital. An innovation in the making, an alternative to secure wallets and the “Ledger”. Why insure your cryptocurrency? As a reminder, cryptocurrency is indeed money. In times of crisis, specialists and experts have even proposed it as a safe haven, in the same way as gold, even if it is effective for transactions and purchases in real. Nowadays, everything can be insured, from one’s material possessions to one’s pet. Insuring your cryptocurrency can be a rational approach.
Thanks to decentralized finance people will be able to lend cryptocurrency for a project, creating an insurance pool which is a grouping of insurers, at a defined interest rate. If a problem happens, for example a hack or theft (very common), the contract will block and launch an investigation to certify an insurance scam.
The project launched will be able to recover the amount of this contract to wipe the losses incurred. A way to insure the most innovative projects thanks to smart contracts.
- Decentralized exchanges
Decentralized exchanges (Dexs) of the currency are done without a platform, from individuals to individuals. How can it be done? Thanks to softwares like “Uniswap” which is a decentralized exchanger. It allows to exchange one cryptocurrency for another. Once the choice is made, you just have to confirm it with your key and swap. These exchanges are simple, but beware of the service fees which are however less expensive than those of a broker.
As you may have understood, DeFi allows the financial system to evolve by applying transparent rules without intermediaries. The blockchain continues to take advantage of innovations and this is certainly only the beginning.