3 July 2020
The fundamental purpose of any product or service built on the principles of blockchain is to be decentralized. That is, there should be no central authority managing the operations of the service. Many developments are being done in the blockchain space to create an alternative for some of the mainstream centralized services. DeFi is one such successful attempt.
DeFi stands for Decentralized Finance, and it is one of the topics that is gaining a lot of attention in the world of blockchain and cryptocurrency. The intention behind the invention of this technology is to make the entire financial world decentralized. In this article, let’s understand the concept and purpose of DeFi in detail.
The Purpose of DeFi
To comprehend the purpose of Decentralized Finance, we must know how traditional financial works and its potential flaws. The fiat currencies that we are currently using as a mode of exchange is heavily centralized. That is, multiple centralized authorities manage these currencies. Institutions like central banks and the corresponding governments have total control over the demand and supply of these fiat currencies.
Centralized systems have failed in many instances because of the faulty decisions taken by some people in these institutions. The hyperinflation that happened in Venezuela is the perfect example. In many cases, we also let these central authorities take control of our assets while expecting some returns. That is, to save the money and gain some interest from it, we deposit them in banks in the form of fixed or recurring deposits.
The banks use these funds to invest in the global stock market and make huge returns out of it. Only a fraction of those returns is passed on to us, and they enjoy the rest. The interest rates are also being slashed as the global inflation rate is increasing with time. Also, we know the risks involved in stock trading and investing. The point we are trying to make here is that the centralized financial system has potential flaws, and the need for decentralization in this space is very much there.
How does DeFi work?
Decentralized Finance is not a single product or service but an amalgamation of them. The list includes smart contracts, automated protocols, decentralized applications, etc. Currently, Ethereum’s blockchain offers excellent flexibility for companies to build their DeFi applications. However, various other platforms offer these services as well.
Simply put, DeFi is an open, decentralized, and transparent financial ecosystem. Here, we can build an end number of applications on a particular blockchain and integrate them to form a potential decentralized network. The primary motto of DeFi is to offer you complete control of your assets. This is only possible because of blockchain technology. Exciting developments are happening in this space as fin-tech companies are coming up with open-source protocols to enable the trading of these assets through decentralized exchanges.
Hence, traders and investors can expect high returns, as there are no intermediaries. It is crucial to know that this is an ever-growing network as it is public and open-source. So, developers and blockchain technologists worldwide get to collaborate and build new protocols to keep the system constantly updated.
Reasons that make DeFi interesting
- While the traditional financial system is extremely centralized, DeFi works almost autonomously. The rules of the transaction are embedded in a Smart Contract as a code. It automatically gets executed once all the conditions of the transactions are met.
- High transparency is achieved as the smart contract code is available for anyone to check, understand, and verify. All the details of the transaction are clearly mentioned in the smart contract, which builds a significant amount of trust between parties.
- The contents in the contract are public for anyone to view, which may raise some privacy concerns. However, the identity linked to that contract and transaction is anonymous or at least pseudonymous. That is, the real identity of the person won’t be revealed unless they wish to.
- DeFi applications offer a lot of flexibility and customization, as many dApps (Decentralized Apps) can be integrated to make decentralized financial transactions more convenient.
Kyber Network, Uniswap, OpenSea, MarkerDAO, and Compound are some of the most popular DeFi applications prevailing in the market. Please do your research to know what problems these companies are solving. Cheers!