Decentralized Finance, also known as DeFi, uses blockchain technology to offer traditional financial services like lending, borrowing, insurance, and mortgages to name a few. DeFi does not rely on a centralized bank, lender or exchange to conduct transactions. Instead, DeFi uses peer to peer technology or dedicated software as a “middleperson” which gives people more control over their financial transactions. This also allows for more people across the globe to have access to these services.
DeFi is gaining popularity because of the challenges with the current financial system. To name a few:
- Privileged few have control over the global financial systems
- No reliance on intermediaries
- Barrier to entry for new players is very difficult
- Difficult for people globally to use the current financial system based on geography, gender, and socioeconomic status
Although DeFi is in its infancy, it has the potential to overhaul the financial sector. DeFi services are becoming more appealing globally. Lending, borrowing, and trading. All without asking for permission from a central authority is becoming very attractive. This technology provides new opportunities for developing countries and people with low income who do not have access to services such as credit.
DeFi applications use smart contracts running on the Etherium blockchain technology. Smart contracts are applications that execute based on specific criteria. There is no person or centralized institution responsible for executing the contract. It is all done programmatically. This automated software program execution is one of the benefits that DeFi provides. There is no intermediary. Assets are escrowed in the smart contracts. These smart contracts are validated on the public block chain. And, because smart contracts are executed automatically, there is no back end work resulting in lower overhead.
Due to the decentralized nature of Blockchain, there is no middleperson or entity involved with approving or managing the transactions. Blockchain writes the transactions to many nodes eliminating a single point of failure and reducing the risks of tampering with transactions. One would have to modify the transactions across all nodes which is extremely difficult to accomplish. This speaks to the security of BlockChain.
Although there are many benefits to DeFi, the industry is still maturing. Poorly written smart contracts have bugs and security vulnerabilities. They require security audits which can be pricey in the short term. Not conducting security audits on smart contracts can result in code being vulnerable to exploitation by cyber criminals. Another issue with DeFi are transaction speeds are slow. This is due to 80% of DeFi applications run on the Etherium blockchain. Some transactions can take seconds to minutes. This is not viable for services which require millisecond latency in their transactions.
With all its shortcomings, Defi has a promising future. The issues will be addressed as more security audits occur with smart contracts. Transaction times will speed up dramatically with ETH 2.0. A more enhanced version of the Etherium blockchain. It is exciting to see where DeFi evolves to in the next 1-2-5 years.
Let us know your thoughts on DeFi, good or bad, in the comments section.