Decentralized finance “Defi” is a general term given to a group of services, digital currencies, and blockchain protocols that provide services similar to those offered by traditional banks and financial institutions, but without the intermediary and oversight role that these institutions exercise. Decentralized finance projects often rely on software incubated by blockchain networks. The chain is larger, which means that it rarely owns its own blockchain, and many of these services operate using smart contracts and decentralized applications based on other blockchains, such as Ethereum, Cosmos, and others.
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| Decentralized Finance (Defi) What is it and what are its uses? |
How does decentralized finance (Defi) work?
In order to understand this clearly, we must first understand how banks operate in the case of loans; When you deposit your money in the bank, the bank may give you an interest of 1%, for example, but it, in turn, lends your money - or part of it - to another customer at an interest of 2%, for example, and he gets 1%, and often the percentage that the bank gets is greater than the percentage that received by the depositor.
In decentralized finance, the role of the intermediary exercised by the bank is abolished, and thus the lending party benefits from higher interest, and the borrowing party from lower interest, usual thanks to the removal of costs for the bank, and the role of the bank is replaced by a smart contract that contains rules governing how to deposit and borrow from it and interest rates And other rules that will govern the relationship between the various parties.
The main uses of decentralized finance
It is difficult to set clear boundaries for decentralized finance, but we can identify the most prominent services and processes that are usually categorized under decentralized finance:
- Lending
As explained above, decentralized financing protocols can be used to lend and borrow, and as banks usually request mortgages that can be resorted to in the event of default, such as real estate and cars, borrowing through decentralized finance requires mortgaging digital currencies that remain locked in the account of the smart contract that manages the process until the loan is repaid.
- Payment Services
The currencies of decentralized finance are used to settle payments directly between individuals and institutions beyond traditional intermediaries, thus saving the various parties high transfer fees and long processing times.
- Trade traditional assets
Many decentralized finance services are used to trade traditional assets such as stocks, coins, and precious metals, by creating their digital counterparts as tokens or non-fungible tokens.
- Decentralized trading platforms
While cryptocurrencies are decentralized in nature, most cryptocurrency trading today gets centralized platforms, which has led to the emergence of decentralized trading platforms operated by smart contracts that allow cryptocurrencies to be exchanged against each other, but are often considered to be of high risk as they are associated with money laundering and other sources of resources. Illegal income and many trading platforms refuse to receive or monetize the assets coming from these platforms due to the ignorance of the identity of their users.
- Stablecoins
Today, stable currencies are the bridge between digital currencies and fiat currencies, and many rely on stable currency services to facilitate the trading of digital currencies without the need to use cash during the trading process. Oasis.
Disadvantages and risks of decentralized finance Decentralized
finance services involve some risks, most of which are related to the nature of digital currencies themselves, most notably the absence of customer protection, as loans and deposits provided by banks are often protected to a certain extent by governments, which guarantee the recovery of deposits and bank balances in cases of bank insolvency.
At the same time, in many cases, decentralized finance services depend on expectations of the value of digital currencies used as collateral, which threatens the stability of these currencies in cases of a sharp decline in digital currencies, although the collateral required is usually equal to or greater than the value of loans.
Decentralized finance provides wide opportunities for people who are usually marginalized from the traditional financial system, especially those with limited income, but at the same time, due to the lack of disclosure of the identity of the parties to its various operations, it is considered a high level of risk, due to its ease of use in financing illegal activities, money laundering, and others. It is a fairly controlled process in the traditional financial system.