Decentralized finance is a new and emerging industry that is taking the world by storm. It is essentially an ecosystem of decentralized applications (DApps) where users are able to access financial services without the need for intermediaries.
In this article, we will be discussing what DeFi is, and how it connects with cryptocurrency.
What is DeFi?
Decentralized finance, or DeFi for short, is an industry that allows users to access financial services without the need of intermediaries such as banks. The ecosystem includes decentralized applications (DApps) which are designed with a focus on trustless interactions and open protocols.
These DApps are typically architected in order to provide a service where there’s no central control entity such as a bank that would take responsibility over transactions when you make payments via another platform like PayPal. This is what makes them so trustworthy because they do not rely solely on one centralized authority – instead all parts of the network have some degree of power and influence in decision-making processes throughout the system.
DeFi can be divided into two categories: fully decentralized systems, and hybrid systems.
DeFi: fully decentralized systems or hybrid systems.
Fully decentralized DeFi networks are defined by many of the following:
- A protocol that is open source, meaning anyone can contribute to it
- An aim for decentralization in terms of power distribution among nodes on a network (i.e., no single entity has more control than any other)
- The use of crypto-token ownership as incentive for participation
Hybrid systems have some centralization but are still considered DeFi because they also typically rely on cryptocurrency holdings as incentives and involve fewer intermediaries between buyer/seller in transactions.
How does DeFi work?
When we dig into the technical aspect of DeFi, we’ll notice how these systems leverage blockchain technology and the tokenization of assets. Specifically, DeFi networks rely on smart contracts as a way to automate transactions.
Smart contracts are computer protocols that have rules encoded in them that can be enforced by an automated system like the Ethereum network without any need for human input or control
Once programmed into a protocol, they cannot be updated or changed – which means errors won’t cause unintended consequences
For example, if two parties agreed to exchange one bitcoin for five ethers (a cryptocurrency) when we use fiat currency this would require multiple intermediaries such as banks and brokers who take fees along with days between settlement time. With DeFi using smart contract programming there’s no middleman, which means you can transact directly with your counterparty, the transaction settles immediately and you can exchange without having to worry about fees.
Decentralized exchanges, prediction markets and stablecoins
There are many use cases of DeFi including decentralized exchanges, prediction markets and stablecoins.
Decentralized Exchange: a group network where information is not controlled by any single person or organization.
Prediction Markets: these allow people to make predictions on future events in order for them to earn rewards when they turn out correct.
Stablecoin: this type of cryptocurrency has a low volatility because its value is pegged against fiat currency like the US dollar (USD) rather than being determined by supply and demand forces within an open market. In other words, there’s no risk of devaluation since the price will always stay at one USD even if someone wants to buy more tokens.
Who can use DeFi?
Decentralized finance can be used in different industries: healthcare (FinTech), real estate (proptech) and more. The most common use cases are:
- People who want to invest in cryptocurrencies.
- Companies that want a cheaper and more efficient way of raising capital.
- Developers looking for funding their projects, instead of or in addition to traditional methods like venture capitalist firms or crowdfunding platforms such as Kickstarter.
- Individuals seeking investors for their own investments (such as real estate) through online crowd investing platforms. These are typically called Real Estate Investment Trusts (REIT).
What are the risks of using a decentralized financial system?
Since DeFi is a relatively new and under-researched area, there are not many studies that show what its drawbacks might be.
Some people view bitcoin as too volatile to truly function well in this capacity because it can fluctuate wildly on any given day with no warning whatsoever. This could make things difficult for investors who want stable returns and do not wish to take much risk.
Another drawback is volatility; Bitcoin prices change constantly, so someone may invest in something they think will give them good returns but then find out later that their investment has suddenly gone down significantly due to fluctuations in price over time – which means by investing now they’ve lost money since the starting
Is the future of finance decentralized?
The future of finance may be decentralized, but it’s not here yet. Blockchain technology is changing the way we think about money, and this has led to a new generation of financial products that are more efficient than ever before.
The decentralized nature of blockchain has the potential to change everything. There’s a lot of skepticism and fear around the idea, but it is worth investing time in understanding what this technology could do for us all. The future of finance may be decentralized as we know it today—but only if people are willing to take risks and invest their time into learning about how blockchains work. Will you?
