Decentralized Finance or DeFi refers to the various financial services that utilize blockchain technology and cryptocurrencies to allow direct money transactions between people. The main aim behind this was to make financial services more accessible, cheaper, and easier for everyone.
One of the best things about decentralized finance is that there is no central controlling figure or authority like governments or banks. You can directly transfer your money or assets by using smart contracts and various decentralized applications.
How does DeFi work?
By utilizing various security mechanisms, advanced hardware, and software, and by establishing several P2P financial networks, the decentralized system was able to eliminate the need for intermediaries or brokers like banks. By eliminating them, the DeFi system reduced the cost of transactions that are associated with the traditional way of transferring money.
The DeFi being built on a blockchain-based network, not only eliminates the service fees but also adds an additional layer of security to these transactions. This makes them virtually nearly impossible to be tampered with.
Blockchains are distributed digital ledgers that are updated by all participating nodes (computers). Every transaction that takes place in the blockchain is verified by select nodes, with the information regarding the transactions being stored in numerous blocks.
Once the blocks are stored with data and are closed, there is no way to change the information inside them. If you attempt to do so, then an alert will be issued to all the nodes on the network. This is one of the main reasons behind the blockchain’s impenetrable security.
Applications of decentralized financial systems
Now that we learned a lot about decentralized finance and a little bit about how it works, let’s now discuss the various applications of the DeFi system.
- Financial inclusion: It is the ability of individuals and businesses to be able to do financial transactions that are affordable, useful, and sustainable. The traditional banking system may not be available to all without a valid account in the respective banks. The DeFi system offers a viable alternative solution for this, where anyone with a smartphone and a steady internet connection has access to various financial services, regardless of their background and status in society.
- Possibility of new income sources: The DeFi system not only provides individuals with various financial services but also have the ability to provide them with an additional source of income. The prime example of this is the Staking mechanism employed by various decentralized exchanges. Apart from this, there are also several other ways of earning money from the DeFi system like yield farming and investing.
- Accessibility: This is one of the main features of the Decentralized Financial system. Anyone with a decent internet connection can use the DeFi platform and make transactions, no matter where they are.
- High interest rate with low fees: In the DeFi platform, the interest rate negotiation takes place directly between the 2 parties involved. After the negotiations are finished, they can directly make the transaction through the network.
- Autonomy: The DeFi platforms don’t have a central controlling authority, thereby eliminating the service costs of the transactions that take place in the network.
- Security & Transparency: All the transactions that take place in the DeFi platforms are recorded in the smart contracts. But even though the details of the transactions are available, the identity of the sender and receiver remains confidential.
Conclusion
As the technologies advance with each day, the DeFi apps are revolutionizing the way transactions take place. By removing the central controlling authority, not only did they reduce the cost of transactions but they also brought a sense of security and autonomy within the network.
The main aim of the decentralized financial system was to eliminate the need for a third party and to facilitate direct peer-to-peer transactions. As days progress by, the DeFi is gradually overcoming almost all the shortcomings of the traditional banking system.
But the DeFi like any other project so far, is in its budding stage. There will be a lot of concerns and challenges it has to overcome in the near future. As of now, we can only wait and see if the DeFi system is going to replace the traditional banking system or not.
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