Decentralized finance, or DeFi, has become a popular buzzword, especially with proponents of distributed ledger technology, blockchain, and cryptocurrency. Just as cryptocurrency was designed to ultimately take control of money away from governments, DeFi aims to take control of personal finance away from banks and investment firms.
What is DeFi?
Decentralized finance refers to a category of online financial platforms where one or more function is managed via smart contracts or other decentralized, blockchain-enabled, automated processes, rather than by a centralized system. However, as of this writing, there is no DeFi platform that is 100% truly decentralized. Each one still involves some degree of centralization in one or more aspects of its management.
The Current State of DeFi in 2021
Decentralized finance as we know it today is focused on one thing and that is to eliminate the middleman from financial transactions. As such, DeFi mainly relies on Ethereum as the blockchain that is easy to use and tailor according to the needs of a specific system.
What can a typical DeFi platform do today? The range of DeFi products varies significantly, but most systems guarantee the following functions:
1. Cryptocurrency exchange markets are free from central authorities 2. The ability to borrow or land digital coins 3. Near-instant payments from peer to peer 4. Advanced asset management through tokenization 5. The option of predicting asset fluctuations and capitalizing on your predictions
The Promise of Decentralized Finance
The aim of decentralization is to take control away from the establishment. Whether that establishment is a national government, regulators, or a centuries-old bank, proponents of decentralization see institutions as inherently corrupt and believe that people deserve greater freedom of how they store or spend their money. They also believe that the layers of bureaucracy slow things down to a pace that is not congruent with modern life, making it too difficult to send money across national borders or secure a loan to take advantage of a narrow window of opportunity.
The current bank customers may not even be the primary target audience for DeFi platforms. Many DeFi solutions are looking to engage with the unbanked or underbanked — people who currently have limited access to traditional financial services. This includes those in developing countries, rural areas, and people working in shadow economies.
Benefits of DeFi
Decentralized financial systems are not just a theoretical concept with little to no use, but rather highly practical inventions with tons of real-world benefits. Some of the major advantages of DeFi include:
- The lack of centralized authority that monitors and controls financial transactions strictly. With DeFi, users’ deposits are free from external interventions.
- Every participant in the DeFi system gains his own portion of financial sovereignty and democratic control. You know how the system works and you know that nothing can interfere with the process.
- DeFi can reach the highest level of accessibility because, in theory, it only takes the Internet connection to gain access to the system regardless of your location.
- Decentralization and the blockchain-powered platform make DeFi much safer and more difficult to penetrate by traditional hackers and malicious activities.
Cons of Decentralized Finance
DeFi projects encounter formidable difficulties in the scalability of host blockchain from various perspectives. First of all, the DeFi transactions require unbelievably extended periods of time for confirmation.
At the same time, the transactions on DeFi protocols could become highly expensive during the period of congestion. For example, Ethereum could showcase capabilities for processing almost 13 transactions every second with Ethereum at full capacity. On the contrary, the centralized counterparts for DeFi could accommodate thousands of transactions in the concerned period.
The concerns of uncertainty also make a mark in the advantages and disadvantages of decentralized finance. In event of instability in a blockchain hosting a DeFi project, the project could automatically inherit instability from the host blockchain. As of now, the Ethereum blockchain is going through various changes. For instance, the mistakes committed during the transition from PoW consensus to the new Eth 2.0 PoS system can lead to risks.
The shared responsibility factor works negatively for users. The DeFi projects do not take responsibility for your mistakes. All they do is taking away the intermediaries, and it is the users who have to take responsibility for their funds and assets. Therefore, DeFi space needs tools that could prevent possibilities of human mistakes and errors.
Decentralized finance has become a promising favorite for transforming the conventional benchmarks of financial services. Most important of all, DeFi could foster the application of blockchain in the financial services sector. With the value benefits of transparency, immutability, and decentralization, DeFi space still has to encounter obstacles like scalability.