Lending and borrowing have been observed for centuries. Before establishing banks, individuals would borrow from other affluent individuals nearby.
These loans were obtained to establish a business, expand an existing one, or purchase personal items. The interest rate fluctuated in the upper double digits depending on your relationship with other affluent individuals.
Banks were introduced later. Although the process was simplified and interest rates were reduced, obtaining a loan from a bank still required a significant amount of effort, such as submitting documents for Know Your Customer (KYC) checks, which are measures to verify the identity of customers, and demonstrating the ability to repay the loan.
Most of this critical financial sector is overseen by centralized systems that have been in place for an extended period and are regulated by authorized financial institutions and banks.
Historically, consumers were required to interact with an intermediary, such as governing financial bodies such as banks and exchanges, to obtain a vehicle loan, mortgage a new home, purchase stocks, invest in funds, or access any financial service, such as insurance or retirement planning.
This necessitates modifications to two components.
- Banks and exchanges receive some of the profits from lending transactions.
- Additionally, these agencies implement gatekeeping measures (KYC checks) for individuals who require these financial services to guarantee security.
This results in a protracted process involving numerous individuals, which can generate friction points within the formal credit system.
Currently, technological advancements are facilitating significant modifications in this area. Technology facilitates direct communication between lenders and borrowers, eliminating the need for a central agency or intermediary.
This is a significant factor contributing to the increasing popularity of decentralized finance.
The primary objective of decentralized finance is to empower the individual, eliminating the need for an intermediary and thereby facilitating and streamlining financial transactions, including lending between peers.
DeFi services can be implemented in various critical financial sectors, including lending, borrowing, funding, trading, derivatives, and insurance.
Exploring the realm of DeFi
Decentralized finance is the concept of administering money without the involvement of large institutions or corporations.
It is established through peer-to-peer transactions, which means that individuals perform a greater portion of the work performed by banks and other financial institutions.
It is founded on open-source technology and lacks a controlling authority that can deny consumers access to any financial products or services they desire. This enables continuous market exchanges.
DeFi is founded on Blockchain technology, which facilitates the development of financial applications and protocols with programmable functionality.
Smart contracts, which incorporate deal agreements, automatically execute transactions on the blockchain.
Smart contracts include the parameters of the agreement and the agreement between the parties involved. These contracts establish a rules-based ecosystem that enables financial transactions, including lending and investing, to occur without the involvement of third parties such as banks and brokerage houses.
Unlike traditional finance, where numerous individuals and systems may be involved in processing, verifying, and logging transactions, transactions occur autonomously when the smart contract conditions are satisfied. The immutable ledger is the repository for transaction records, independently verified by thousands of computers worldwide.
Advantages of DeFi
Blockchain technology not only facilitates decentralized finance but also paves the way for innovative financial security and transparency. It unlocks liquidity and development opportunities, supporting an integrated and standard economic system, and promising a future of exciting possibilities.
There are numerous advantages to DeFi.
- Programmability
Smart contracts facilitate the automation of contract execution and enable the development of new digital assets and financial instruments.
The concept of programmable money is extremely potent. Therefore, the release or retraction of funds will be contingent upon fulfilling specific criteria.
This concept is expected to be implemented in various government initiatives in the future. Consider the situation in which the government only releases funds to the required parties after ensuring the necessary criteria have been met.
- Interoperability
Developers and product teams can use DeFi to integrate third-party applications and combine established protocols with multiple custom interfaces. Consequently, DeFi protocols are occasionally referred to as “money Legos.”
- Transparency
A public blockchain broadcasts all transactions for other users to verify. This level of transparency surrounding transaction data enables the analysis of rich data and guarantees that network activity is publicly accessible.
DeFi protocols are also included in Ethereum, and their code is accessible to anyone interested in viewing, auditing, and building upon it.
- Unauthorized
DeFi’s permissionless, open access is a critical distinction from traditional finance. Typically, applications developed on Ethereum can be accessed by anyone with a crypto wallet and Internet access, irrespective of location. This requires a minimal amount of funds.
- Self-Custody
Web wallets are employed in conjunction with permissionless financial applications and protocols by participants in the DeFi market to ensure that they maintain custody of their assets and control of their private data.
DeFi is founded on open-source technology. This enables all individuals to access financial information through internal connections and applications.
Consumers can engage in financial transactions with their colleagues via internet connection. The relevant actors in the system have access to the distributed databases that contain all of the transactions, facilitating the establishment of a digital record of all transactions.
The overall procedure is highly cost-effective and seamless due to the absence of a central agency.
Additionally, the programmability concept provides a plethora of options to various actors in the financial ecosystem.
It has the potential to significantly reduce the number of inefficient and error-prone processes, such as manual data entry and reconciliation, and eliminate corruption within the system, such as fraudulent transactions and insider trading.
This system fosters accountability and transparency by storing data in a decentralized database, which is a database that is distributed across multiple locations or nodes.
By employing cryptography, this database is exceedingly secure and eliminates the necessity for an institution, such as a bank or merchant, to verify transactions.
