Following the debut of Bitcoin in 2009, a thriving industry grew up around the asset, its concept, and its underlying technology. The crypto and blockchain space has several niches where initiatives and businesses build solutions for diverse use cases.
The decentralised finance (DeFi) sector, which was formed as an alternative to traditional financial services, is one such niche. DeFi is made up of smart contracts, which in turn power decentralised apps (DApps) and protocols. Many of the first DeFi applications were created on Ethereum, and the majority of the ecosystem’s total value locked (TVL) remains there.
At its heart, Bitcoin (BTC) possesses characteristics regarded as cornerstones of decentralisation. DeFi, on the other hand, expands on those qualities by introducing new capabilities.
DeFi, a subgenre within the larger crypto sector, provides many of the conventional financial world’s services in a way that is governed by the masses rather than a central institution or entity.
Lending may have started it all, but DeFi applications now provide participants with access to saving, investing, trading, market-making, and other services. The ultimate goal of decentralised finance is to challenge and eventually replace established financial service providers. DeFi frequently employs open-source technology, allowing anyone to build on pre-existing apps in a permissionless, composable manner.
Centralised Finance v/s Decentralised Finance
Commercial banks will be used as an example in this comparison. In the traditional world, financial institutions are used to hold money, borrow capital, earn interest, send transactions, and so on. Commercial banks have a long and proven track record of success. Commercial banks can offer insurance and security measures to deter and defend against theft.
On the other hand, such institutions hold and control your assets to some extent. Banking hours limit certain actions, and transactions might be time-consuming, necessitating back-end settlement. Furthermore, commercial banks require precise customer information and identification documents in order to participate.
DeFi is a financial products and services segment that operates without the intervention of banks or other third-party corporations and is accessible to anybody with an internet connection. Because the decentralised financial market never sleeps, transactions take place in near real-time, and no intermediary has the capacity to stop them. You can keep your cryptocurrency on PCs, hardware wallets, and other devices and obtain access to it at any time.
The asset class and processes are managed by people or companies in centralised finance. In decentralised finance, however, assets are managed by a group of smart protocols. It all comes down to trusting the people or organisations behind the platform. CeFi systems, such as Coinbase.com, are custodial, which means they hold your cryptocurrency for you. However, you may use a Coinbase wallet just like a traditional currency wallet, providing you with complete control over your crypto holdings.
Overall, DeFi gives members access to borrowing and lending markets, the ability to take long and short positions on cryptocurrencies, make profits through yield farming, and more. Decentralized finance has the potential to be a game-changer for the world’s 2 billion unbanked individuals, who, for various reasons, do not have access to traditional financial services.
Importance of DeFi
DeFi eliminates intermediaries and enables decentralised banking, which was previously impossible owing to the necessity to get transactions approved by third parties. Customers are typically unaware of the underlying legislation controlling financial products and services, as demonstrated by the global financial crisis of 2008–09.
The purpose of DeFi is to build a financial market that is open, trustless, and permissionless. Much of the DeFi technology tries to improve the current financial system, potentially enhancing user experience (for both businesses and their clients).