Decentralized finance operates based on a trustless and transparent mechanism without the presence of any intermediaries in the system. It is supported by a public blockchain network that is commonly accessible to all.
What Are the Issues Faced by Traditional Finance at the Moment?
- Not every individual in the world can access basic financial services easily.
- Statistics say that close to 1.7 billion people constitute the unbanked population.
- Despite the massive reach of financial institutions all over the world, they are unable to deliver their services to some sections of the population.
- Though many unbanked people have mobile phones in their hands, they are not active in digital banking.
How Decentralized Finance Development Will Help to Solve the Existing Crisis?
- It removes the chances of a single point of failure by storing and sharing the records of users among different nodes in a network.
- There is no need to follow the governance structure and rules imposed by a central authority.
- The cost per interaction for users is minimal.
- Users will have 100% control over their assets and funds due to the presence of decentralization and blockchain technology without facing any restrictions.
- Any developer can build products and protocols on top of the blockchain network.
- The returns offered in decentralized finance is higher than that of the conventional financial system.
The Various Decentralized Finance Solutions Being Offered in the Market Now
- Lending – With the rapid increase in business activities, the need for credit has shot up many times. In DeFi lending, users can borrow assets from each other by pledging another asset as collateral. Once the borrowing period has been completed, the principal amount along with the specified interest has to be paid by the borrower to the creditor without fail. The collateral will be used to cover up the lender’s loss.
- Derivative instruments – It can be in the form of asset-backed tokens, alternative insurance, or p2p protocols established for prediction markets. A popular example would be Synthetix, a derivatives liquidity protocol where assets are created based on fiat currencies. Rewards can be earned by providing collateral to the Synthetix protocol. It enables users to trade derivatives with infinite liquidity.
- Decentralized exchanges – Instead of depending on the order books used by centralized exchanges, they use liquidity pools. Crypto assets are exchanged using the liquidity pools with the help of the smart contracts deployed on the blockchain network. A famous example of a decentralized exchange would be Uniswap. The exchange rate is set by the creator of the market and will change according to the level of trading activity on the platform. Trading activity is intensified due to the availability of profitable arbitrage opportunities. The best price will be given for the user when he wants to exchange a token after checking across all the available reserves.
- Asset management – Assets of the users are managed in a decentralized way. The tokens will represent underlying assets. The process of rebalancing will be handled by the robust smart contract. Decentralized finance helps to reduce the barriers of investment for investors. The expenses incurred for paying traditional asset managers is higher than decentralized finance.
- Facilitating smooth settlement of payments – Decentralized Finance development has made micropayments inexpensive and more efficient. Users can deposit their funds and conduct as many transactions they want without exceeding the amount deposited. All the transactions executed on the network will be recorded off-chain. It is highly scalable and does not depend on any third-party custodians.
The Benefits Offered by DeFi Open Finance Development
- Ensures full autonomy – The users have full access to their funds and assets anytime. There is no centralized authority for freezing your account, seizing your assets, or block your transactions.
- Is more accessible to the common man – Many people do not have an opportunity to access the basic financial services leaving them at a tremendous disadvantage. Centralized financial institutions are failing to target them leaving those sections of the population highly vulnerable. By operating without any intermediaries in the system, decentralized finance platforms can afford to access them.
- Is more tradeable – Defi based assets are more exchangeable than traditional assets. It also opens up investment to those people who cannot afford it in conventional finance. A small portion can be invested by the users instead of committing a high-value investment in one shot.
- More transparent – The data related to Decentralized finance solutions are publicly available via websites like Defi pulse and Defi prime. You can compare different projects, the returns offered to the investors, and even track the transactions made on their platform.
Read also: DeFi Lending And Borrowing: Transforming Traditional Financial Services
The Shortcomings of DeFi Development
Many users have lost their holdings before since they have lost their private keys or forgot their passwords. Unlike traditional finance, decentralized finance does not provide insurance for lost funds. Smart contracts can also suffer from various bugs in the form of underflows, overflows, and reentrancy attacks which can compromise the system. The DeFi regulations are unclear and there is no active enforcement. Hence, there is hesitancy on the part of both businesses and investors to take part in Decentralized Finance.
DeFi will witness a huge increase in its value in the future with more participants joining the system. There is a rich possibility that DeFi may indeed overtake traditional finance in the years to come.