August 26, 2020 Okereke Innocent

Decentralized Finance – Financial Enabler of the Future

Decentralized Finance

The invention of Blockchain has resonated several solutions; one such solution is cryptocurrency, and they have paved ways for many ways of doing things, including banking. Initially, space had limited or restricted adoption, but thanks to the recent use cases and applications of Blockchain and cryptocurrency like Decentralized Finance and DApp, among others that brought several use cases to space.

First, it was the Initial Coin Offering (ICO), that aims to deepen cryptocurrency and Blockchain adoption in general. As soon as the ICO era was becoming somehow obsolete, Decentralized Finance (DeFi) took the lead.

DeFi is the financial enabler of the future. It uses emerging technologies like Blockchain, Yield farming, internet, etc. to bring financial inclusion. In other words, it is an open financial movement that breaks the barrier of the centralized system hence broadly known as Open Finance.

However, before diving deep, here is a simplified definition of DeFi, according to Binance Academy:

“The movement promotes the use of decentralized networks and open-source software to create multiple types of financial services and products. The idea is to develop and operate financial dApps on top of a transparent and trustless framework, such as permissionless blockchains and other peer-to-peer (P2P) protocols.” 

DeFi and Traditional Banking

Decentralized Finance bridges the gap between the banking system and the average user. It tries to decentralize and distribute banking among users and take banking decisions away from central parties.  Usually, there are bureaucracies in traditional banking. However, Decentralized Finance protocols are promising to lift them. Consequently, you will get to appreciate the distinctions of DeFi to conventional banking with the following points:

Digitalize Assets

Digital assets holders are deprived of making transactions in traditional banking, simply because of trust and other constraints. However, the Decentralized Finance assures digital asset inclusion, where users and holders alike can transact, invest, and own as needed. Meanwhile, digital assets include electronic, encrypted, and distributed money. For instance, the DeFi gives a cryptocurrency holder access to banking. 

Transparent 

Since the underlying technologies of DeFi combine a trustless, transparent, and secured system, transactions on DeFi are transparent and are recorded on a Blockchain. It restores the broken link of transparency in the system.

Interoperable

If you have tried building applications or even performing some transactions through the traditional system, you may either be limited or have several compatibility issues. However, the DeFi protocols built on dApps are designed mainly as open sources for users to perform services of choice. That said, a user who wants to save, loan, lend, stake, etc., can interchangeably do that without filing documents and possibly seeking approvals from the management. 

Global access 

DeFi platforms operate decentralized applications (dApps). Therefore, they provide access to everyone who has access to the internet. Also, the underlying technology of DeFi, Blockchain, makes it easy for everyone across the globe to connect to the dApp. 

Concurrently, unlike the traditional banking systems where you require a third party for access when the need arises, DeFi solves that for you. 

Moreso, the more you require third parties to gain access to the platform, you have to pay some fees, therefore, since there is no such barrier in DeFi, you have no such fee to consider.

Distributed and Permissionless

There are permissioned, public, private, and permissionless Blockchain distributed ledger models network depending on the use case, the DeFi are designed as permissionless. Usually, the type of distributed ledger, a single ledger system that shows the transactions in a timestamp manner, is designed to suit the use case. Therefore, the DeFi operates a permissionless and distributed ledger model where users only need to follow the Smart Contract’s terms to perform transactions. 

Meanwhile, the Smart Contract functionalities of DeFi is a Blockchain protocol that automates deals, negotiation, and agreements between parties. Consequently, it helps the DeFi community to self bank upon reaching the terms enshrined in the contract. Contrary to the traditional system where users may be panicking if there is a failure to fulfill agreements, the Smart Contract reverses the deals once agreements are not met.

Also read our latest article on Polkadot Blockchain network here.

Uses and Applications of DeFi

Like every other invention of Blockchain, Open Finance has several and increasing numbers of use cases. However, let’s start by looking at the functions of Decentralized Finance. 

In a holistic view, the functions of DeFi include; 

  1. Creating a monetary banking system
  2. Peer to Peer networks for trustless transactions
  3. Deploying financial instruments to further provide liquidity, market making, and overall financial inclusion.

However, the various functions created opportunities for various types of DeFi services; funding protocols, software development tools, index construction, subscription payment protocols, data analysis applications, KYC, AML, and other identity management services. Nonetheless, the following use cases manifests the various functions and types of DeFi services:

Borrowing and Lending 

Some people mistake decentralized borrowing and lending. However, borrowing refers to getting loans while lending is making a deposit for interest or issuing out loans. 

Before Decentralized Finance, borrowers and lenders approach third parties to sign or fill some documents which may not be transparent. Consequently, Open Financial movement enabled the parties; borrowers and lenders to transact 

Stablecoin and Decentralized Reserve

Since the cryptocurrency assets are largely volatile, stable coin and the decentralized reserve is a way of balancing the price fluctuations. They are achieved by pegging digital assets to a basket of currencies or goods, unlike Bitcoin, Ethereum, among others that are not pegged on anything. For instance, MakerDao, WBTC, and others enabled asset-backed cryptocurrencies to reduce price swings and market uncertainties. 

Therefore, a stablecoin somehow makes crypto legitimate as it draws the attention of the states who are currently developing or researching Central Bank Digital Currencies. 

Savings 

Before now, if you want to save money, you’d find a bank to save. However, you may no longer bother looking for a central party to deposit your money to save. Therefore, you can simply save through a decentralized saving platform. Therein, you only need to deposit once you agree to the terms and conditions and the interest rate within a stipulated time. Consequently, you have your keys to finance through Open Finance. Concurrently, most stablecoin offering platforms offer to save including, Dia, Gemini Dollar, and WBTC among others.

Automated Token Exchange 

One of the applications of Open Finance is to automate trades and enable market making. Therefore, it does that through a mechanism called “Automated Token Exchange”. 

Consequently, it uses an innovative mechanism known as Automated Market Making to automatically settle trades near the market price and allow users to provide liquidity to the market. While there are several projects automating trades and offering liquidity, Uniswap is the most popular one. However, other decentralized exchanges are offering the same. They include but not limited to; AirSwap, Bancor, Kyber, IDEX, Paradex, and Radar Relay.

Decentralized Marketplace 

These applications of DeFi enable financial innovations. For instance, decentralized exchanges, synthetic assets, decentralized prediction markets, and many more. Contrary to the centralized marketplaces, it simplifies digital assets trading between users across the nodes without the need for a third party or central control system. 

It hosts decentralized protocols that match trades and improves liquidity, tokenization, and other things that make decentralized trading work. Concurrently, Bisq, Airswap Protocol, IDEX, Bancor, Kyber Network, Uniswap, and Binance DEX among others, are examples of the DeFi decentralized market use cases. 

Conclusion 

According to Coingecko, DeFi Coin and DEX, is currently $14B, $451M market cap, and trading volume respectively. Therefore, it could be inferred that the market is new and has rapid growth potential. Consequently, it is a statement of fact that DeFi is the future of finance. However, it can achieve that in a matter of time and only when individuals have full access to self-banking. 

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