Decentralized Finance (DeFi): What is it and What are its Potentials?

DeFi (decentralized finance) is a blanket term for emerging digital financial platforms based on blockchain technology, which is another use case of blockchain like cryptocurrency, NFT, etc. The Federal Reserve and Securities and Exchange Commission (SEC) in the USA or the Reserve Bank of India and Securities and Exchange Board of India (SEBI) in India define the rules for and control the traditional financial institutions like banks, exchanges, and financial markets, which people depend on for their banking and financial services. In contrast, DeFi with its decentralized structure allows individuals to make financial transactions by way of peer-to-peer (P2P) digital exchanges.

DeFi delivers to you all the services that traditional bank provides, such as depositing and earning interest, borrowing, lending, buying insurance, trading derivatives, trading assets, and more, in a faster, paperless, and decentralized manner without a central or third-party involvement.  Similar to crypto, DeFi is global, peer-to-peer - transacting directly between two people, not through a centralized system-, pseudonymous - alias or fictitious name without relieving the identity -, and open to anyone without any criteria. In short, DeFi empowers you to hold money in your wallet and transfer funds instantly without the need for any approval and fees. 


The importance of DeFi 

DeFi is a digital alternative to Wall Street in the USA or Dalal Street in India or their equivalent in other countries but without all the associated costs or control. It has the potential to build more open, faster, and fair financial markets that are accessible to anyone with an internet connection.

Peer-to-peer (P2P) is a core feature of blockchain and the financial transactions behind DeFi, in which the transactions are completed without the involvement of any other party or entity. Under the P2P method in DeFi, a person who needs loans can make a request and an algorithm in the app would identify and match a lender with the borrower who agrees on the terms each other before the loan is disbursed. The DeFi transactions are performed through a decentralized application (dApp) that follows the same blockchain process.


Core Features of DeFi 

The following features define the fundamentals of DeFi:

  • Accessibility: DeFi can be accessed by anyone with an internet connection to make transactions with anyone located in any part of the world.
  • Low or No fee: There is no or very minimal fee involved in the transactions made through DeFi platforms
  • Flexibility: It allows flexibility for contract parties like the lender and borrower to directly negotiate interest rates and lend or borrow funds.
  • Security and Transparency: The records of transactions completed through DeFi are visible for anyone in the network to review but without revealing your identity and cannot be reversed or changed.
  • Autonomy: The decentralized structure of DeFi ensures that there is no risk of adversity or bankruptcy.

How does DeFi work?

Decentralized finance runs on blockchain technology, which is a distributed and secured database or ledger. People engage with DeFi through software applications called decentralized apps (dApps). In the blockchain, transactions are recorded in blocks and then verified by other users through consensus mechanisms like proof of work (PoW) or proof of stake (PoS). The blocks in the blockchain are "chained" together in chronological order by connecting the new block to the previous block. The records on the blockchain cannot be altered or reversed and that makes the transactions done on any blockchain application like DeFi secure. You don’t have to open an account as is done in conventional banks. 

Put it in another way, DeFi is a financial services platform that allows people to perform all the financial services currently available within the traditional banking, financial, and market ecosystems with all the advantages of blockchain technology. 

Key Takeaways

  • DeFi works without third parties and centralized authority.
  • The components of DeFi include stablecoins, software, and hardware.
  • The infrastructure for DeFi and its regulation are constantly evolving.
  • It allows peer-to-peer transactions with people anywhere on the globe if connected to the internet
  • It has all the features of blockchain like speed, security, low-cost transaction
  • It is complex to understand and at times risky due to volatility and scams and fraud involved in it

The future potentials of DeFi

The regulation is a major factor that will decide the future of DeFi, being a borderless platform. In the absence of any authority that controls the systems like in the case of traditional financial systems at the global level, the regulatory framework has to be accepted by all the countries and at the same time without interfering with their functions through control. Another element that has to be tackled is the security threats as the ecosystem is prone to infrastructural setbacks, hacks, and scams. 

The questions that need to be answered with respect to the future of DeFi include who at the global level will draft and enforce regulations, who will investigate a financial crime that occurs across borders, and how will the protocols and DeFi apps be regulated. Other concerns can be about the stability, energy requirements, carbon footprint, system failures, and upgrades regarding DeFi and dApps. Many governments and central banks are coming out with digital currencies built on blockchain. 

The Bottom Line

Decentralized finance is an evolving financial technology that tries to do everything that the centralized financial system does and more but in a more efficient, inexpensive, and democratized manner. This is a general view of the platform and you should consult an expert professional before making decisions on using DeFi for financial transactions. DeFi is opening up a lot of business opportunities primarily in fintech and that needs relevantly skilled talents to design, develop and implement the technology. Since the talents in this segment are scarce and expensive, the best way for businesses especially small businesses and startups to get this done is to depend on platforms like Task as a Service (TaaS) that make a large pool of skilled resources available on different models at your convenience and a cost that does involve an overhead component.

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