Financial services are among the oldest services that people use for their daily activities. They affect lots of our actions and experiences in working and also living. Good financial service helps us use our money more wisely and improve earnings, too. Decentralized finance or DeFi is a new concept in the financial sector that wants to disrupt the traditional space by offering different features.
As the name implies, decentralized financial services don’t rely on a centralized organization like bank, exchange, and brokerage to help users. They provide famous products like loans, interests, trading, futures, etc., using blockchain. In DeFi, users communicate with each other directly to use and offer services.
DeFi – What is it, And What is it for?
DeFi was born to disrupt the financial sector. Multiple platforms in this sector try to provide standard financial services differently. A common definition for DeFi calls it a complex of applications that run on blockchain to provide trustless and permissionless financial services.
Don’t forget that there are multiple centralized finance (CeFi) systems that offer cryptocurrency services. So, don’t confuse DeFi with cryptocurrency.
Decentralized financial services can provide all of the products that users receive from traditional platforms. You can see some of the common services below:
- Wealth management
Developers who work on the DeFi platforms have to combine multiple components to provide a comprehensive platform for users. The fundamental elements of DeFi services are blockchain and smart contracts. Financial services trigger actions like reward payment, interest calculation, insurance payment, and many others, using smart contracts. The other essential components of DeFi systems are oracles. They help the decentralized applications gather data from real-world sources – also called off-chain sources.
Ethereum blockchain was the first network to be used for DeFi applications. Some sources call MakerDAO the first DeFi system that was launched in 2015. There are now numerous decentralized finance services out there that use various blockchains as their infrastructure – or a combination of them. Most decentralized finance services have a stablecoin for their transactions and conversions. They issue a governance token, too, that lets community members affect the system’s strategic decisions.
A blockchain-based financial service can provide all of the traditional services in a new manner. DeFi services can use public or private blockchains to offer their benefits. But the most crucial part, decentralization, is always there.
Using a decentralized infrastructure for financial products has multiple benefits for end-users. They should not be worried about sanctions or censorship while using DeFi. No centralized organization is responsible for fundamental technology. So, governments can’t control or ban specific users.
Blockchain technology has shown its advantages in multiple sectors in the last years. The speed/security pair is the most important feature it has demonstrated to the world. The pair is present in DeFi, too.
The ownership of digital assets is specific to the user in DeFi. In other words, you control your money’s overall function because of the ownership of private keys in the DeFi system. As a result, no third-party player is needed in decentralized finance activities.
Transparency is another benefit of DeFi. All of the transactions and activities are trackable, and users have full sight of their money.
Is Decentralized Finance Safe?
When we are talking about safety in financial services, trust is the most crucial concept to consider. When looking from this angle, you can see the only reason people believe in the security of traditional financial organizations like a bank is the trust they have in the centralized organization. As a result, the final security concept is not that secure.
In the blockchain world, users trust no one, and everything is under their control. Although some DeFi services are managed and developed by one company, the system’s nature is decentralized.
With all of the benefits that DeFi has regarding security, there are still some instances of hack in those platforms. Premature services that have not implemented the vital security layers sometimes experience harmful breaches. But the most breach cases happen because of the user-error. Some users are not familiar with their DeFi applications and sometimes lose money because of a lack of knowledge.
DeFi Use Cases
As mentioned before, decentralized finance can provide almost all of the financial products you need. Some of them are most popular among cryptocurrency users and have experienced considerable growth since the birth of DeFi. Borrowing/lending and DEX (Decentralized Exchanges) are some of the most popular ones these days.
Borrowing/Lending services in DeFi platforms let users lend cryptocurrencies or any other digital asset to each other without the need for intermediaries. Compound, Dharma, dydx, and bZx are some of the popular ones in this sector.
Cryptocurrency exchanges are very popular among users. They use these services to trade their digital assets and increase earnings. Traditional cryptocurrency exchanges work in a centralized manner and are prone to risks like hacking and institutional fraud.
DeFi platforms offer a decentralized exchange or DEX to users to spot trade or trade futures directly with each other. IDEX, Kyber, and Oasis are some of the most popular DEXs out there.
Insurance has always been an integrated part of financial service, and any bank somehow has to offer that. Users can receive insurance from decentralized finance platforms. They receive insurance in DeFi against multiple risks like price, technology, counterpart, etc. Etherisc is one of the popular DeFi systems in this sector.
Centralized Finance (CeFi) Vs Decentralized Finance (DeFi)
As mentioned before, the essential difference between centralized and decentralized financial services is the ownership of money. In centralized ones, you have to trust a company or team – or a too-big-to-fail bank – to manage your money. But in DeFi, you have full control over the funds and transactions.
Full control may be useful for improving many aspects of financial sectors like transparency and censorship-resistance. But it has some risks because there is no institution to provide protection mechanisms for you. After all, insurance becomes a vital part of DeFi.
From the first days of activity, decentralized finance systems have shown many promises to users. They offer you the ability to manage your money – a digital asset in this case – without the fear of censorship and/or sanctions.
On the other hand, there are still many challenges facing this move that have to be solved to expect more adoption.
Many users still don’t know how to use DeFi products securely. After all, DeFi is no different from other blockchain products and needs way more education and promotion.