Cryptocurrencies have been around for over ten years. They allow us to digitally transfer money and assets across the world without any intermediaries such as banks to process transactions. You can transfer funds from Thailand to the United States within a few hours without leaving your house!
Cryptocurrencies have inspired many other significant innovations, such as Smart Contracts or ICOs. Decentralized Finance (DeFi) is the latest product of the cryptocurrency world that has the potential to change the financial system forever. Let’s find out what Decentralized Finance (DeFi) is and how it can affect your life.
What is Decentralized Finance (DeFi)?
Decentralized Finance (DeFi) is the new financial system that allows financial transactions such as transferring money, getting a mortgage, loaning, or earning interest to be done without any intermediaries like banks.
Financial transactions usually rely on trust. If you want to lend money to someone, you need to trust that you would get the money back; this is where the bank comes in. Banks, or any intermediaries, came in to be the trusted party.
You deposit money in your account and earn interest, while banks loan your money to earn interest. Although it’s similar to you lending money to someone directly, banks have processing costs and risk not getting paid back, so they take some of the profits that you could have earned without an intermediary.
Decentralized Finance (DeFi) uses digital technology such as Smart Contracts on Blockchain instead of banks as a trust factor in processing financial transactions. Blockchain-based technology like DeFi is transparent and checkable.
It allows us to continue using the financial products without high fees and the slow processing time of the middle party. The main objective of DeFi is to make transactions transparent, accessible, and beneficial for everyone as a peer-to-peer platform. Moreover, it also provides access to financial solutions other than the banks. However, investing in DeFi is still considered high-risk since there isn’t any support or defense mechanism to directly manage the risk.
What is Centralized Finance?
Centralized finance is the financial system that we are all familiar with. Almost every aspect of banking, lending, and trading is managed by centralized systems. This centralized system offers a high level of trust since other people are subsidizing your risk. When things go wrong, it might take a shorter time to fix the problems since you know who’s in charge.
On the other hand, CeFi or Centralized Finance is a traditional form of finance. Before DeFi was launched, traders had to go to the centralized trading platforms which manage their capital without owning the private key. Besides, the platforms also determined the listed coins and their fees.
But centralized finance systems come with their challenges. In the event that the entity who is in charge has an issue and the whole system stops, you won’t be able to do anything.
Just like when the bank application crashes or the system is hacked. Centralized finances often slow things down and cost much more than they should without offering any transparency to your money management. The central bank can ease or tighten the money supply as much as they want without us having any control, while a decentralized system provides more transparency and equality.
Benefits of DeFi
Decentralized Finance (DeFi) is unique and has the potential to disrupt the financial market. Let’s see how.
- Cheaper and faster transactions
Most financial transactions require an intermediary. If you want to transfer money from the United States to your parents in Thailand, you need an intermediary like Westen Union or Wise to help process the transactions. You then need to pay for operational costs to them. On the other hand, If you transfer money through online transactions without any intermediaries, you can avoid the costs and frustrating processes altogether.
- Open the world for non-banks
Some non-banked people cannot benefit from the financial products as we all do. For example, without a credit history, people cannot get a loan to expand their businesses. Some can’t even open a bank account to store their money there. DeFi allows anyone to access the service from every corner of the world by just having a cell phone and internet access.
- Easier to start a business
Back in the day, you might need to wait for months to get a business loan. If you are an artist, you might need to wait for an exhibition to sell your paintings. With DeFi, anyone can tokenize any asset and sell them digitally. No more complicated and expensive payment gateways or processes. Fundraising, loans, and payments are also easy, there are fewer barriers to starting new businesses, especially international ones.
- More acceptance
The world is ready for online transitions. Data shows that in Thailand alone, 68.1% of people between 16-64 use financial applications. DeFi allows financial transactions to take place online, similar to financial applications, making people enter the world of DeFi with less hesitation.
What can Decentralized Finance (DeFi) do?
DeFi has been developed for many use cases. Let’s explore three main benefits of Decentralized Finance (DeFi).
- DeFi for lending and borrowing
Today, we leave our money or assets with the banks. We earn little interest while banks use our money to make more money, such as giving loans to people and earning high interest. Instead of leaving your money with banks, you can lend your money directly with DeFi by using digital assets such as Bitcoin. This means you can receive the entire profit from interest without paying processing fees or risk fees to banks.
- Reduce the fluctuation in cryptocurrency with Stablecoins
It’s common knowledge that digital currencies such as Bitcoin fluctuate, making it hard to use them in daily life, but stablecoins do not. A stablecoin is pegged to an underlying asset, such as gold or forex reserves which act as collateral. their valuations remain free from wild swings.
One of the good examples of a Stablecoin is USDT, where every token is worth 1 USD. Besides less fluctuation, stablecoins allows users to create virtual assets on DeFi. You can use any token as collateral, which means you can digitally sell any real-life assets like dollars, gold, real estate, or stocks.
- Raise find digitally with Security Token Framework
There is countless real world out there, so it’s almost impossible to have as many digital assets as there are physical ones. Due to that fact, people developed frameworks to tokenize financial assets like bonds or stock.
Under authorized supervision, we can now digitally/virtually raise funds easier than before instead of going through time-consuming processes like IPOs. With the test of time, we might see that people would prefer the digital ways over the old ways.
DeFi and Smart Contract
A smart contract is a set of conditions that any developer can write to put in a digital contract. For example, you buy a fridge from John. In that case, your payment will then be completed as soon your fridge is shipped, and John will receive it automatically. You don’t need to worry about paying in advance and not receiving the refrigerator. John also has peace of mind since he knows he will get the payment. Everything on the contract is on the Blockchain, which can’t be changed.
A smart contract allows DeFi to process financial transactions such as deposits, withdrawals, and even allows contract parties to use collateral. Smart contracts bring more liquidity to certain markets as it allows users to buy and sell tokenized stocks or fractions of collateral, increasing the capital pool. Decentralized Exchanges usually use Smart Contracts, so they don’t need an intermediary. This is why you need to read the contract (both smart and not smart ones) before
DeFi and Ethereum
At first, interest in DeFi was limited to developers and tech people who understood coding. It takes time for any new technology to see mass adoption. From the graph, as early as in2018, you can see only $50 Million locked in DeFi. Two years later, we see more adoption in the middle of 2020, and the value locked has increased to $700 Million. Only a year after that, the growth has been tremendous, and by mid-2021, there’s $72 Billion value locked in the DeFi market. That’s a growth of over 1400%!
Decentralized Finance has no intermediary, so we need Smart Contracts to help process automated transactions such as paying for fees or creating tokens. 25-30% of DeFi is on the Ethereum Blockchain due to its simplicity and popularity among developers.
There’s no doubt that a higher adoption rate of Decentralized Finance results in a higher price for ETH. Since 2020, more people are using DeFi, and the price of ETH has been rising, even more than BTC, due to its real utility that is more than just payments.
Example of the Most Popular Defi Projects
Concerns about Decentralized Finance (DeFi)
DeFi is still in its very early days and it is complicated for a lot of non-tech savvy people. Some transactions are unique. Investing in DeFi requires deep research, same with any other technologies that evolve fast.
Prices of DeFi tokens also increase a lot in a short time. High volatility means a high risk of investment. So make sure you do your research before putting any money in the game.
Understand DeFi with a basket of Decentralized Finance
A basket of Decentralized Finance is putting all the tokens related to Decentralized Finance (DeFi) together and weighting them to create an Index: the DeFi Index Perpetual Futures. This basket of Decentralized Finance lets you keep a close eye on the DeFi market, including market trends and
Summary of Decentralized Finance (DeFi)
Decentralized Finance (DeFi) used to be seen as something that could only work far into the future. However, we have seen more adoption and use cases in the real world, showing that problems are waiting to be solved by DeFi.
We are excited to see how DeFi can offer better financial products for everyone. The possibilities are limitless; from higher interest rates than your traditional saving accounts to a simple way to raise funds for your business, and much more.
If you are ready to step into the world of decentralized finance, look no further and start for free with Zipmex, one of Asia’s fastest-growing digital asset investment platforms.
