
What is DeFi?
DeFi stands for Decentralized Finance, which is a new way of providing financial services through blockchain, mainly Ethereum. DeFi enables most of the things offered by traditional banks earning interest, borrowing, investing, buying insurance, trading derivatives, trading assets and morebut it’s faster, and doesn’t require paperwork or a third party. DeFi is open, peer-to-peer (meaning directly between two people, not over a centralized system), pseudonymous and accessible to everyone. In this blog we will try to explain how DeFi works, and what are its advantages and disadvantages. We hope that you will enjoy reading and discover some new opportunities that DeFi offers.
Source: cointelegraph
How does DeFi work?
DeFi operates on the basis of blockchain technology, which allows secure and transparent storage and transfer of data without the need for intermediaries or central authorities. The most commonly used blochain for DeFi is Ethereum, which uses so-called smart contracts. Smart contracts are programs that are automatically executed when certain conditions are met, without human involvement. For example, a smart contract can send money from one account to another when some goal is met. DeFi uses smart contracts to create a variety of financial applications and services, called dapps (decentralized applications). Dapps allow users to participate in a variety of activities, such as borrowing, investing, trading, insurance, and more. Dapps are open and global, meaning they can be used by anyone with an internet connection, regardless of their identity or location. Dapps are also transparent and secure, as their code and data can be viewed and verified on the blockchain. This also carries risks given that anyone can look at the code and use potential errors in the code to steal funds. On the other hand, this can serve to make it easier to detect errors and faster developer intervention to fix the error. To use DeFi, users need to have a digital wallet, which allows them to store and send cryptocurrencies or other digital tokens. A digital wallet is like a personal bank account, but without the need to register or disclose personal information. Users can connect their wallet to different dapps and start using decentralized apps.
Source: cointelegraph
Advantages of decentralized finance
DeFi has many advantages over traditional, centralized finance. Today we will list only some of the most important:
- Availability: DeFi apps are open to anyone who has access to the internet and cryptocurrencies, without the need for identification, registration or approval. This means that DeFi is available for people who do not have access to banking services or who are excluded from the formal financial system.
- Greater control and transparency: DeFi users have full control over their assets and transactions, without the need to trust intermediaries or third parties such as banks. All transactions are publicly visible and verifiable on the blockchain, which ensures transparency and accountability. Also, DeFi users can make decisions independently, without the approval of banks. Of course, this has a negative side. Often there is a loss of funds due to irresponsible behavior of users who are not properly educated on the topic of finance.
- Speed and efficiency: DeFi transactions are executed automatically using smart contracts, without the need for manual processing, checks or delays. This means that DeFi can offer faster, cheaper and more flexible financial services, without restrictions on working hours, geographic boundaries or currency differences.
- Innovation and diversity: DeFi is an area of constant innovation and experimentation, where new applications, products and services are constantly being created. Also, DeFi enables interoperability and collaboration between different blockchains and cryptocurrencies.
All of the above advantages create a free market, and thus competition, and a constant need for progress.
Source: cointelegraph
Shortcomings of decentralized finance
Decentralized finance (DeFi) has a number of benefits, but they are not without risks. Some of the disadvantages of DeFi are:
- Technical complexity: DeFi applications require a high level of technical knowledge and skills from users, who must understand how blockchain technology, smart contracts, cryptocurrencies and protocols work. Also, users must be able to manage their private keys and wallets, and keep track of changes and upgrades on DeFi platforms. If users make a mistake or lose their keys, they can permanently lose their property or become victims of fraud or hacking attacks. This tells us that at least for now, decentralized finance is not for the average financial service user.
- Regulatory uncertainty: DeFi applications are not clearly regulated by traditional regulatory frameworks, which can create legal uncertainty and expose users to potential sanctions or penalties. Also, DeFi applications may be subject to censorship or banby by state authorities, which may limit their availability and functionality. In addition, DeFi applications can be used for money laundering, tax evasion, terrorist financing or other illegal activities, which can damage reputation and trust in the DeFi sector.
- Security vulnerabilities: DeFi applications rely on smart contracts that execute on the blockchain without human intervention. However, smart contracts may contain bugs, omissions, or vulnerabilities that can lead to loss of funds, hacking, or misuse. Also, DeFi applications may be exposed to technical problems, network congestion, denial of service attacks, or other disruptions that may affect their stability and reliability.
- Market volatility: DeFi applications are exposed to high volatility and uncertainty of cryptocurrency markets, which can affect their liquidity and profitability. All this can cause a sudden change in interest rates, transaction fees that users pay to use applications, the value of collateral, etc.
Source: cointelegraph
Conclusion
Decentralized finance (DeFi) is a new way of providing financial services through blockchain and smart contracts, without the mediation of traditional institutions. DeFi allows users to independently manage their money, assets and data, and to participate in various activities such as lending, loan, trading, insurance, etc. DeFi has many advantages, such as transparency, efficiency, accessibility, innovation, and resistance to censorship and manipulation. However, DeFi also has some disadvantages, such as high risks, technical complexity, regulatory uncertainty and lack of user protection. DeFi is still in development and has plenty of room for improvement and growth. This concept is revolutionary, and has the potential to change the world of finance and economics, but also bring new challenges and responsibilities for users.