The internet’s boom has propelled significant enhancements in the user experience that traditional financial systems offer. Digital currencies and other financial services allow us to use money in a “seamless” and “hassle-free” manner. Yet, these developments have done little to solve the core problems of traditional finance: centralisation and lack of transparency.
In the world of intermediary-ridden and highly-siloed financial systems, end-users have almost no control. From how banks use the money in their savings accounts to how much money the government prints, the user has no meaningful authority.
Multiple intermediaries—governments, banks, insurance providers, and other financial institutions—control the system, while also implying overhead costs for the users. This also heightens the risk of financial crises such as market crashes, inflation, and scams. Moreover, with a global unbanked population of over 1.7 billion, these systems foster unequal access to financial services.
Faced with these issues, there has been a substantial drive for change over the past decade as Decentralised Finance or DeFi is persistently challenging the status quo of centralised finance. For many in the blockchain-cryptocurrency community, DeFi is a “financial revolution” that began with Bitcoin in 2008 and is now being played out majorly on Ethereum’s platform.
What is Decentralised Finance?
Suppose, person A wants to send €5 to person B, or, pay for a coffee. Eliminating the need to rely upon the aforementioned intermediaries, a decentralised financial ecosystem would enable this transaction to occur peer-to-peer—that is, directly between the sender and receiver. Now, to put it simply, DeFi is the sum total of the processes, innovations, technologies, and other solutions that make this possible.
Given the absence of a central governing entity, DeFi systems are also known as Open Financial Systems. Rather than “trusted intermediaries”—which also represent single points of errors—DeFi uses blockchain and cryptography to ensure the validity, as well as the security of transactions. Having said that, let us consider the three major pillars to decentralised finance.
1. Smart Contracts
Blocks of code that replace traditional Agreements. Here, the terms of the contract are codified to automatically perform certain actions when a pre-defined condition is met. For instance, pay X amount to B, on so-and-so date. Using cryptographic encryptions, smart contracts are tamper-proof and impart heightened security to blockchain-based transactions.
2. Decentralised Applications (dApps)
These are much like traditional financial applications, but decentralised. Instead of centralised servers, dApps are hosted on blockchains and store data on the shared ledger which the network members can access and audit at will.
It is through dApps that users interact with DeFi systems. Presently, Ethereum is the platform that most dApps developers are using, but there are also others like RSK.
With their value pegged to real-world assets, stablecoins solve the volatility (unstable price) issues of cryptocurrencies. Consequently, stablecoins can be used for day-to-day transactions and long-term investments, among other things. DAI by MakerDAO is a popular example in this regard.
DeFi’s Implications for the Future of Money
While the holistic range of DeFi’s implications extends much beyond this article’s scope, let us conclude by highlighting some of the immediate ways in which decentralisation transforms our financial systems.
First, using smart contracts, DeFi systems are inherently compliant and neither party can deflect from the terms of the agreement. Second, these systems are fully transparent and auditable, since every member has equal access to the network’s database. Third, decentralisation posits the control with the user, and lastly, it ensures global access to financial services.
In all, DeFi comes with the possibility of not only solving the major pain points of traditional finance but can completely alter the ways in which we use money. Sign-up to bitFlyer today and start using cryptocurrencies to participate in the DeFi movement.
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