In this latest ZB Shorts article, we briefly explore the subject of DeFi, and the impact it is making on the business world. While often grouped with other trendy sounding buzzwords like NFTs and Metaverse, its potential is unparalleled — just like its buzzword counterparts. DeFi is the concept that underpins cryptocurrency, and is here to stay.
Decentralized Finance, also known as ‘DeFi’, is a growing financial technology which eliminates the requirement of central banks, government agencies or third parties to facilitate financial transactions. The term DeFi originated back in 2018, by a group of entrepreneurs, looking at ways to eliminate centralized banking systems.
There are several advantages for those of us that use DeFi technology — one of the main advantages being that it provides financial accessibility to anyone who has an internet connection. Financial transactions using DeFi are easier and faster than centralized finance.
Apart from the elimination of the service fees and charges acquired by traditional bank systems and financial institutions, people have complete control of their finances and can trade at any time, from anywhere, around the world.
Moreover, DeFi inculcates different types of financial services such as exchange, trade, borrow, and lend without the requirement of a third party.
DeFi technology is formed upon secured distributed ledgers. These
distributed ledgers are synchronized databases that have been distributed to multiple people across different locations. Since many people have access to the copy of the records, this technology becomes very secure and resistant to cyber attacks.
DeFi provides countless financial services such as lending, receiving loans,
peer-to-peer trading, savings, smart contracts etc, using decentralized Apps (dApps) without the involvement of a middleman.
Decentralized Apps are digital applications that handle peer-to-peer transactions and run on the blockchain. Most of these dApps are created on the Ethereum platform. The creation of the Ethereum network in 2015 has a major role to play in the DeFi system.
Smart contracts, which originated from the Ethereum platform, are programs that are operated when conditions are fulfilled. This encouraged many developers to build dApps, introducing more diverse possibilities in the sphere of finance while utilizing blockchain security, accessibility and dependability.
One of the major risks that is involved with the DeFi systems is that there is very little insurance to protect funds during the event of fraudulent activity. Whereas this security is available in centralized systems. Another drawback faced is the smart contract vulnerability; i.e. if there is a slight error in the code of the contract, it could lead to tremendous loss of funds. In addition, there are other disadvantages such as energy requirements, system maintenance, and upgrades.
However, the security that underpins the operations of DeFi systems is a very reasonable caveat to the lack of official insurance available to its patrons.
Overall, while DeFi is still learning as it goes, its potential is already being realized. The movement away from centralized banking systems continues to build momentum, and any solution that provides an alternative will be underpinned by DeFi.
