Topic 4: Introduction to Decentralized Finance (DeFi) – A new Fintech Revolution (Part 1)
- What is Decentralized Finance?
- The Foundation of DeFi
- An overview on how DeFi operates
- The Benefits of Decentralized Finance
- Homework task
Decentralized finance (DeFi) is currently one of the popular innovations that have gone viral in the Blockchain and Crypto space. When you follow the daily Crypto news you realize that many blockchain and Crypto enthusiasts are talking about DeFi. With DeFi gaining more and more traction every other day, the traditional financial system is under a serious threat of being dissolved by the newly emerging Decentralized financial ecosystem.
What is Decentralized Finance - DeFi?
Decentralized finance basically means the financial sector without the financial intermediaries call them “the 3rd parties” which include banks, brokerages, stock exchanges, etc. The Underlying power behind DeFi is blockchain Technology. Surely Blockchain technology is on the quest to decentralize everything that can be decentralized on this planet.
The Foundation of DeFi
Blockchain Technology is the foundation of Decentralized Finance. You cannot appreciate DeFi without having an understanding of Blockchain Technology. Well, in our very first topic we did some basic introduction to Blockchain technology. Let’s recap a little bit of that topic here; Blockchain Technology is described as the arrangement of data in form of Blocks which is Secured by Cryptography.
The introduction of Bitcoin in 2009 became one of the potential and successful use cases for Blockchain Technology. However, Bitcoin had a limitation in features. This prompted Vitalik Butelin and a group of developers to invent Ethereum in 2015.
Basing on the careful study of Bitcoin and its limitations, Ether was founded with a unique computational logic termed “Smart Contracts”. Therefore we can describe the Ethereum Blockchain as “a smart contracts Blockchain”. What are Smart Contracts? These are open-source automated data transactions that are coded/programmed basing on a set of agreed terms and conditions of the contract. In other words, they are executed automatically when certain parameters are met.
Though DeFi is still in its initial development stages, Billions of dollars are already locked up in the various DeFi projects implying that it’s a trustworthy innovation that has a great potential of revolutionizing and dominating the future global financial system.
A brief overview of how DeFi operates
DeFi basically operates on Smart contracts (DeFi protocols) which are built on top of the Blockchain. Ethereum smart contracts Blockchain is a pioneering Blockchain for the DeFi ecosystem where transactions are executed automatically following the predesigned protocols. On DeFi, some people can opt to lend their assets, borrow assets or even provide liquidity/trade digital assets. People earn interest when they loan out their Digital assets. Those who are borrowing have to give in Collateral that is ‘Ether’ and are given another digital asset that they can choose to trade with or cash out.
Benefits of Decentralized Finance
All transactions are public, implying that they can be viewed and confirmed by other users on the network. This is opposed to the traditional banking system where only specific bank personnel can have access to all the transactions happening in the bank system.
The traditional/centralized financial system is undeniably doing an incredible job in the world of finance in the managing of people’s funds but these are still greatly lacking in the aspect of Transparency. I believe it’s a fundamental right for its clients to know what their money is being used for by the entrusted financial intermediaries. Unfortunately, these do not disclose that information fully to their clients.
With DeFi, Transparency is one of its core benefits that have created a whole new trustworthy financial architecture that eliminates doubts and fears regarding the whereabouts of clients money.
Data Security/ Immutability
The data transactions running through the DeFi protocols cannot be tampered with by anyone due to the highly decentralized infrastructure that it operates in, hence a secure financial ecosystem.
Relative Low transaction fees
Being that it excludes 3rd parties, the fees charged on every transaction are relatively lower than those in the traditional financial systems. Investors are always on the lookout for financial systems that charge relatively minimal costs in order for them to have and enjoy bigger profit margins from any deal of their online business deals, could be in trading and they want to generate more profits on minimal transaction costs. DeFi has a Decentralized exchange such as Uniswap that automatically levy relatively minimal transaction costs based on the prevailing forces of demand in the crypto market.
Permissionless/ Unlimited access to the DeFi ecosystem
Unlike the traditional financial systems that have limited or no access at all to certain database information, DeFi is permissionless, implying that anyone in the world, it does not matter their geographical location, can have full access to the entire DeFi ecosystem as long as his connected to the internet. It also does not matter whether someone has a minimum balance on his account. He can still have his way around the DeFi ecosystem.
Every person owns their money and personal data. Through the use of the Web3 wallets including “Meta Mask” a user can transfer his money anywhere from his wallet, possibly to an exchange or even to a decentralized finance application in order to participate in the lending of his assets for an interest.
Developers can be able to customize the user interface, integrate and build other 3rd party applications, on top of the existing DeFi protocols, courtesy of the flexible Ethereum software 'Stack' that ensures that integration of applications.
The DeFi ecosystem is highly programmable in such a way that its smart contracts are automatically executed thus enabling the creation of new financial and digital assets.
In Conclusion, though DeFi, is still in its initial development stages, it is already proven that DeFi has a great potential of revolutionizing the entire global financial system by offering such a unique decentralized financial ecosystem that eliminates the financial intermediaries(3rd parties).
Homework task: Briefly explain each of the following DeFi apps
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