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What is Defi and Why is it the Hot Trending Topic in the Crypto World?

16 Oct 2020 | News

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The cryptocurrency industry has substantially evolved from bitcoin cryptocurrency trading. Decentralized Finance, also known as DeFi, is the latest trending topic in the blockchain and cryptocurrency industry. Decentralized Finance enables developing applications on open-source blockchain networks. The potential benefits of DeFi in the financial ecosystem are vast and wide.  

 In this article, we understand what is the meaning of decentralized finance and why has it drawn considerable attention in recent times.  

What is Decentralized Finance? 

Decentralized Finance (DeFi) refers to decentralized applications built on open-source blockchain network in the financial sector. Decentralized applications enable a more accessible and transparent financial ecosystem. DeFi has the potential to transform the current infrastructure of banking as well as finance through various products and services.  

The current financial ecosystem is yet inaccessible, encompasses multiple intermediaries, and operates within a centralized environment. Decentralized applications on blockchain enable peer to peer networks, in which users have complete control over their funds and assets. The DeFi ecosystem facilitates a decentralized environment eliminating intermediaries and central point of failure.  

Moreover, decentralized finance facilitates interoperability within different applications and easier access to multiple financial products as well as services. The dApps are developed on open-source blockchain platforms like Ethereum and can be accessed through smartphones.  

Decentralized Finance (DeFi) Benefits 

DeFi is a tool for expanding outreach of a financial ecosystem. Under the currency infrastructure, financial services are inaccessible to weaker sections of society. DeFi facilitates innovations to create an inclusive economy with access to banking and finance.  

Traditional finance incorporates various intermediaries to reduce the scope of disputes. Decentralized finance facilitates peer to peer networks removing intermediaries from between. Instead, interactions between participants are through a network of smart contracts. This further reduces costs and minimizes human intervention.  

Furthermore, DeFi apps are built on open-source blockchain protocols like Ethereum. Multiple dApps catering to different financial services from loans to insurance can be created through DeFi protocol. Moreover, existing data can be transferred to a decentralized network thereby facilitating interoperability between different platforms.  

Additionally, supportive infrastructures like increasing use of smartphones and the internet are propelling the use-cases for DeFi. The services in decentralized finance can be accessed via the network of dApps through smartphones and the internet. This has further increased the applications and use-cases of decentralized finance.  

Decentralized Finance Applications 

Leveraging the ecosystem of blockchain technology, DeFi facilitates various applications in the banking and finance sector. Let’s take a look at the use-cases of decentralized finance for the financial ecosystem.

  1. DeFi in borrowing and lending 

    The traditional finance services of borrowing and lending are highly centralized, have limited accessibility, high barriers for weaker section of society, and lack standardized protocols. One of the first applications for DeFi is borrowing and lending.  

    DeFi allows a standardized protocol for lending services without any restrictions on geographical locations. Transaction times for settlements are substantially reduced. Moreover, DeFi enables financial services of loans to the unbanked of the globe. It reduces the time and process involved to access lending services under the current ecosystem. Furthermore, through DeFi a new landscape of digital assets can be incorporated in the lending structure. 

  2. DeFi in cross-border remittance

    The billion-dollar cross border remittance industry lacks technological innovation in the current ecosystem. Moreover, the process is time-consuming, costly, and interlaced with multiple intermediaries. DeFi facilitates instant transfers between any two parties irrespective of their geographical location, time, and space.  

    Apart from instant transfers, decentralized finance applications also allow direct transfers without any intermediaries with almost negligible transaction fees. Through decentralized finance, remittance fee can be reduced as much as 3%.  

  3. DeFi stablecoins

    Another prominent use case of DeFi is stablecoins- digital currencies that are pegged to a fiat currency. Stablecoins allow leveraging the benefits of blockchain-enabled virtual currencies and removing the factor of volatility in prices. 

    Stablecoins enable innovations in the form of microtransactions along with incorporating decentralization, easy transfers, and negligible transaction fees. Moreover, it also ensures increased security in financial transactions through the use of cryptography. 

  4. DeFi in mortgages and insurance 

    Decentralized finance applications also include the issuance of mortgages and insurance on decentralized and trustless blockchain networks. In traditional finance, services like mortgages and insurance come with high legal fees, counterparty risks, and intermediary organizations.   

    Through the application of smart contracts, the terms and conditions of a contract are embedded in the form of code and deployed on a blockchain platform. This further enables reduced counterparty risks, lesser expenses, and a timely process. It also reduces the intermediaries needed as all the terms are automatically executed without the need of human intervention.  

Decentralized Finance Trends 

While blockchain technology applications are now being explored in various sectors, the banking and finance sector has gained more prevalence than any other in the year 2020. Use-cases of blockchain in the financial ecosystem are explored through decentralized finance applications.  

In February 2020 DeFi token value touched $1 billion. Now, in August 2020, the DeFi token value has reached more than $6 billion. Cryptocurrency tokens developed on DeFi protocol have increased as much as 600% since the beginning of 2020. Even when the cryptocurrency market experienced a downtrend in prices from March to July because of the pandemic crisis, DeFi tokens continued to boom.  

Ethereum continues to dominate the decentralized finance space. Most of the DeFi projects are developed on the open-source Ethereum network.  

Closing Thoughts 

The year 2020 has certainly been dominated by DeFi protocols and projects. Moreover, it continues to drive attention owing to the applications of DeFi in banking and financial sector.  

DeFi has the potential to take away power from centralized institutions and instead place it in the hands of the community. Moreover, DeFi does not only enable a transformation in the existing systems but also propels new technological innovations in the finance sector. From the looks of the current scenario, DeFi is here to stay.