How Decentralized Finance (DeFi) is Disrupting Traditional Lending and Borrowing
Decentralized finance, or DeFi, is inevitably the newest big thing in the Finance industry. This article discusses how DeFi is disrupting traditional lending and borrowing.
The term “decentralized finance” (or “DeFi”) is the most recent trend in the banking and finance industries.
Loans, borrowing, trading, and insurance are typical financial services made possible through DeFi’s decentralized financial system powered by blockchain technology.
It eliminates the need for centralized institutions like banks in financial transactions, allowing users to deal directly with one another.
DeFi has matured into a state-of-the-art technology that can upend the banking industry by providing more accessible, transparent, and secure monetary services.
What is DeFi?
“Decentralized finance,” or “DeFi,” refers to an accounting system that uses a blockchain network.
Decentralized finance, or DeFi, is an option to traditional finance, which banks and other financial institutions centralize.
Instead, it is built on the blockchain network, a computer set that keeps a decentralized record.
DeFi offers various financial services, such as loans, borrowing, selling, and insurance.
All of these are done on the blockchain network. Users can now do business with each other directly without going through banks or other financial institutions.
Smart contracts are used to make deals happen. These contracts automate checking, carrying out, and enforcing a contract’s terms.
Centralized Finance (CeFi) vs. Decentralized Finance (DeFi)
Traditional, centralized financial institutions and banks are not the same as decentralized finance; here’s how;
Centralized Finance (CeFi)
In a centralized financial system, banks and other third parties hold funds and facilitate the transfer of funds from one party to another, each paying a fee for this service.
When a customer pays with a credit card, the transaction begins at the store and continues to the acquiring bank, which then submits the information to the credit card company.
The network then submits a payment request to the bank for the cleared charge.
Each link in the chain is compensated for its part in the transaction since accepting credit and debit cards typically costs businesses money.
Everything from loan applications to the services provided by a local bank falls under the watchful eye of central finance.
Finance décentralisée (DeFi)
Decentralized finance eliminates intermediaries by letting people, merchants, and companies use new technology to make financial transactions.
DeFi uses security protocols, connectivity, software, and hardware improvements to make peer-to-peer banking networks safer and more valuable.
People can lend, trade, and borrow money using software that records and verifies financial actions in multiple financial databases. This software can be used anywhere there is an internet link.
A distributed database can be accessed from many different places because it collects and combines data from all users and uses a consensus method to ensure it is correct.
Decentralized finance eliminates the need for a unified finance model by making it possible for anyone, no matter who they are or where they are, to use financial services anywhere.
Users of DeFi apps have more control over their money because they can use personal wallets and trade services made for them.
Factors that Led to the Rise of DeFi
DeFi is an innovation in finance that has the potential to shake up the industry.
Its popularity has grown rapidly, and by 2021, the entire value protected by DeFi protocols will have surpassed $100 billion.
Several explanations might be offered for DeFi’s meteoric rise, some of them include;
Smart contracts, used in DeFi transactions, are computer programs that can verify, carry out, and enforce the terms of a contract without any human intervention.
Therefore, there is no longer a requirement for intermediaries like banks or institutions financières, which results in lower costs and more efficiency.
DeFi is built on an autonomous network, so no one is in charge of it. Some benefits are easier entry, lower costs, and more openness.
Since DeFi protocols are flexible, blockchain architects can design novel monetary software. Because of this, novel financial products that would be impossible with the Centralized system can be developed.
The open-source blockchain networks on which DeFi systems are based make it easy for them to communicate with one another.
A decentralized financial ecosystem can now be established instead of the centralized one required by conventional finance.
How DeFi is Disrupting Traditional Lending and Borrowing
By making financial services more accessible, transparent, and safe, DeFi has the potential to challenge traditional banking. Here are some examples of how DeFi is disrupting traditional finance:
Due to the public nature of the blockchain ledger, DeFi is more open and accessible than conventional banking.
Because the parameters of a transaction are public knowledge, accountability is enhanced, and dishonesty is minimized.
Unlike conventional lending options, DeFi clients don’t need a bank account or credit history to use the service.
Anyone, no matter where they are or how much money they have, can use DeFi services as long as they have access to the internet.
Due to its distributed nature, DeFi is safer than conventional banking. Since there is no single point of failure, the likelihood of security breaches and cyberattacks is diminished.
Since there are no middlemen like banks or other financial institutions, DeFi is cheaper than traditional banking.
Customers pay less money because transaction fees have gone down and speed has gone up.
The usefulness of Decentralized Finance (DeFi)
Users of DeFi have access to a world of decentralized financial services that don’t require any third parties. To participate in DeFi, you don’t need an account with a crypto market. Some of the most common ways to use DeFi are:
Crypto lending and borrowing
Decentralized Exchanges (DEX)
Staking assets to earn interests
Participate in DAOs
Crypto Lending and Borrowing
Cryptocurrency can be borrowed from or lent to other users through DeFi lending services like Maker, Aave, and Compound.
By pledging Bitcoin or another cryptocurrency as collateral, borrowers can obtain a loan denominated in stablecoins at a competitive interest rate.
Decentralization is advantageous for all parties involved in a transaction since prices and terms can be negotiated more freely than with a monopolistic financial institution.
Smart contracts enforce the terms of the agreement, as they are immutable and go into effect once the predetermined circumstances are met.
Consumers now have access to funds much more quickly than through traditional currency finance channels, as DeFi borrowing is available around the clock, regardless of location.
Decentralized Exchanges (DEX)
Using smart contracts and other decentralized technologies, customers of a échange décentralisé (DEX) can buy, sell, and trade cryptocurrencies straight from their crypto wallets.
Coinbase and Kraken are examples of centralized exchanges; decentralized exchanges are operated solely through peer-to-peer interactions.
In order to keep price discovery for orders of any size, DEXs employ automated market makers (AMMs).
Users are incentivized to use liquidity providers by the fees they pay and the swaps they make.
Unlike traditional centralized exchanges, decentralized marketplaces for buying, selling, and exchanging cryptocurrency typically provide more competitive prices and a more comprehensive selection of available assets.
The popular Uniswap, Sushi Swap, 1 Inch, and Pancake Swap are all examples of decentralized exchanges.
Staking Assets to Earn Interests
DeFi staking is another popular way to use decentralized finance. This is when crypto holders “stake” their assets in a smart contract in exchange for interest payments or other benefits.
Most of the time, these benefits are much better than a savings account’s interest rate.
Stablecoins, which are digital assets tied to the dollar, have also made it possible for users to earn interest on crypto assets used in these DeFi markets.
This has become a popular way to earn interest while protecting yourself from the price instability of crypto.
The best way to tokenize holdings, which can be used in DeFi protocols, is to change fiat currency like the U.S. dollar into a stablecoin like USDC.
DeFi lending platforms have become a popular way to keep money instead of putting it in standard savings accounts with low-interest rates.
Participate in DAOs
Decentralized autonomous organizations (DAOs) are groups led by a community with a common purpose.
Community members create the smart contract that governs the DAO’s functioning.
This may involve deciding which new projects to undertake and allocating existing monies.
Examples of applications include collectively held venture capital firms and membership-approved charitable organizations.
How Safe is DeFi?
Before doing anything in the DeFi space, it’s normal to wonder how safe it is.
The rules for Defi and its many uses are still not clear, and there aren’t as many protections for consumers as there are in traditional banking systems.
So, investing in DeFi stays risky and should only be done carefully.
Everybody knows that if a business proposition or undertaking sounds too good to be true, it probably is.
DeFi is a game-changer for the financial industry and nothing short of a revolution for digital assets.
Despite technological advancements, common sense remains a powerful tool for protecting oneself from cybercriminals.
DeFi uses cryptocurrencies and blockchain technologies to disrupt the banking industry.
DeFi has many advantages over conventional banking systems, including security, cheap fees, adaptability, and compatibility with Crypto wallets.