One of the most exciting aspects of crypto, especially Ethereum, is the potential to harness its power: whether it’s programmable money or programmable contracts.
DeFi (decentralized finance) is one of the ways in which Ethereum can be utilized in this manner.
DeFi has taken the spotlight as one of the most discussed emerging technologies in this new digital age.
Grand View Research, Inc has recently stated that the global DeFi market size is projected to reach over $231 billion by 2030 and expand at a CAGR of 42.5 percent from 2022 to 2030.
According to Statista, the number of DeFi users has increased by 300 thousand since the beginning of 2022.
Therefore, the concept of the DeFi financial system is worth discussing. Moreover, software development companies like Yalantis follow new fintech trends like DeFi to deliver high-quality software solutions for startups and enterprises.
This article will be especially useful for those interested in various DeFi products and those who want to build their own DeFi product. In this post, we answer the following questions:
- What is DeFi and how does it work?
- What are its pros over traditional banking systems?
- How does DeFi interrelate with crypto?
- What are the risks and drawbacks of DeFi?
DeFi In A Nutshell
DeFi is a kind of financial system created on top of blockchain. DeFi is a set of global protocols and systems that allow users to exchange value without having to rely on any centralized service provider or third-party intermediary like a bank or government agency.
The purpose of DeFi is in providing a more effective, clear, and equitable financial system than traditional financial institutions offer.
DeFi is the natural evolution of cryptocurrency, which is based on peer-to-peer payments and trustless transactions.
DeFi offers transparency and efficiency by leveraging smart contracts, open-source code, and cryptographic protocols.
A good example of how this works is Compound, which allows users to lend money and receive interest payments in exchange for collateral.
The platform uses Ethereum smart contracts to automate this process without relying on any trusted third parties or intermediaries.
This is just one example of how DeFi can be used as an alternative to traditional financial institutions like banks and other lending services that charge high fees for their services.
Examples of DeFi include lending platforms such as BlockFi; marketplaces like OpenSea; stablecoins such as MakerDAO’s DAI; decentralized liquidity platforms like Aave; and prediction markets such as Augur’s Reputation System (REP).
Key Benefits Of Decentralized Finance
DeFi has many benefits over traditional banking systems. For example, because there are no banks acting as intermediaries in decentralized finance, transaction fees are much lower than they would be with traditional banking systems.
There is also no need for a bank account since all transactions are conducted directly between users through peer-to-peer exchanges.
This makes it easier for people who don’t have access to traditional banking services to participate in the economy by making deposits into their own personal wallets instead of having to rely on credit cards and loans from banks.
There Are More Benefits Of DeFi Worth Mentioning:
- DeFs provides better security than traditional finance. Data cannot be altered or lost because it’s stored on a blockchain.
- Decentralized finance reduces the need for trust. No one party needs to be trusted with holding your money securely.
- Decentralized finance eliminates middlemen and friction costs, bringing down fees and making transactions more efficient.
The cost savings can also be passed onto users, who benefit from lower fees with increased competition between providers (which increases transparency).
Now it’s time to figure out how DeFi operates.
How Does DeFi Work?
Decentralized finance works in much the same way as blockchain technology: People use their computers to confirm transactions on a public ledger.
Instead of mining bitcoin, however, they’re verifying transactions from other users. These people can earn cryptocurrency for their efforts.
The process starts with someone wanting to make a transaction – perhaps they want to buy something online or pay their rent or mortgage.
This person enters their transaction into a smart contract platform like Ethereum or NEO, which automatically executes it when certain conditions are met (for example: when enough people confirm the transaction).
The smart contract sends these funds directly from one account to another without involving an intermediary such as a bank or credit card company (though some platforms offer these features).
DeFi has faced hurdles that may hinder its worldwide spread, as is the case with all new technology breakthroughs.
Why Is The DeFi Market Challenging?
We can compare the crypto market to the wild west. It’s a place where you can invest in ICOs and make a fortune, or lose everything.
There are no consumer protections in place to stop you from losing money. And if you’re not careful, hackers can steal your digital currency from your “wallet” with just one keystroke.
As the DeFi market continues to grow, there are several factors that make it complex for newcomers to navigate:
- The first hurdle is that most DeFi applications require users to run their own full node or use a decentralized exchange (DEX). This means that they need access to a computer with enough memory and CPU power to execute code in real-time.
- In addition, many existing DEXs require users to have an Ethereum address or ERC20 token-compatible wallet which can be difficult for non-technical users who may not know how to set up their own full node or an Ethereum wallet.
- There are many decentralized finance protocols in existence today. However, most of them are still in the early stages and not easily accessible by the average investor. The lack of user-friendly interfaces and high barriers to entry have made it hard for new users to get involved with DeFi applications.
Afterword
Despite the challenges viewed above, we can all see the DeFi space shaping up to be a powerful, long term investment avenue for future commerce.
DeFi is developing and there are many obstacles to overcome before it gets mainstream.
But if you think about how much time we’ve had with centralized finance and how quickly things have changed in that sector over the past few decades, then it’s easy to see how much opportunity there is for decentralization to take over as well.
As blockchain gets more popular, DeFi will become an increasingly important part of crypto trading.