Why everyone is talking about DeFi
In traditional finance model, economic prosperity or hardship radiate outwards from key hubs, toward the rest of the global economy. Though traditional model worked well in the last century, the financial crisis and, subsequently, the Great Recession, revealed the flaw in this architecture. The balance sheet problems for a couple of large financial institutions, such as London and New York, produced a domino effect of tumbling economies and the onset of the global recession. Customer trust in banking has been low since the 2008–09 recession, due to the subsequent credit crunch, bank bailouts, and austerity policies — not to mention scandals involving fraud and market rigging by a number of well-known names.
There is a dire need for an alternate system of finance and this is why everyone is talking about Defi.
How does DeFi work?
Decentralized finance (DeFi) is a notion that crypto entrepreneurs can recreate traditional financial instruments in a decentralized architecture, outside of companies’ and governments’ control. It uses cryptocurrency and blockchain technology to eliminate central authorities to carry out financial services such as banking, loans, mortgages, and more. The primary purpose here is to establish an open-source, transparent, and permission less ecosystem without any central authority owning the power over financial transactions. It allows participants to control their assets, efficiently conduct peer-to-peer exchanges and build decentralized applications (dApps).
Once a transaction is carried out in a traditional banking system, its details are recorded in a private ledger owned and monitored by a financial institution. However, in DeFi, the financial transactions are stored in a computer code on a decentralized public ledger. All participants using DeFi applications and platforms have an identical copy of the general ledger. This ledger holds the information of every transaction in encryption code. Since decentralized blockchain platforms and applications are immutable, the records of ownership cannot be modified or deleted by a third party providing security in verifying transactions and storing their data.
Decentralized Finance replaces the intermediaries or central authorities with smart contracts. A smart contract automates agreement terms between buyers and sellers to make these decentralized financial products possible. Most of the decentralized applications are often created using Ethereum blockchain. The components of DeFi are stablecoins, use cases, and a software stack that enable the development of applications. The infrastructure and use cases for DeFi are however still in development.
DeFi applications provide users with more control over their money through personal wallets and trading services that explicitly cater to individual users instead of institutions.
Adoption of DeFi
For the first time, US Securities and Exchange Commission (SEC) has made a major shift towards embracing DeFi by approving an ethereum-based fund, Arca, This is an important development, since financial innovation is faced with hostile environment created by regulations written for a the long-gone era. Dut to this some major DeFi projects have failed such as New-Jersey-based Basis, which concluded it couldn’t work within the SEC rules and returned US$133 million to investors in 2018.
Mainstream players are getting involved causing a surge in DeFi. The second reason causing a surge in DeFi is many high-street financial institutions accepting DeFi, and seeking ways to participate. For example, 75 of the world’s biggest banks are adopting blockchain.
Major asset management funds have also started taking DeFi seriously including the world’s largest crypto investment fund, Grayscale.
Third reason is COVID-19 pandemic. It has caused global interest rates even lower. DeFi offers higher returns than high-street institutions.
Last reason for the surge in DeFi tokens buying is people wanting to take part in their explosive growth.
Conclusion
But like it or not, we can say that decentralized finance can prove to be the next big thing in the technology world since it provides advantages to all the sectors looking for a secured financial infrastructure. With blockchain technology as its backbone, DeFi is has a high probability of getting incorporated by various organizations.The question is how to develop it with checks and balances that minimize the risks and potential benefits as widely as possible. That is the challenge for the next few years.
