Growth Of DeFi

DeFi (Credit: Marketfeed)

Decentralized Finance, aka DeFi, is an emerging peer-to-peer technology that runs on Ethereum and other Blockchain technologies. Thus, it processes financial transactions after eliminating the third parties and paperwork. Moreover, you can have interest, insurance, debt, assets, and more as offered by a typical bank. In short, DeFi works for digital money or cryptocurrency.

Working Of DeFi

DeFi runs through dapps (Decentralized Apps) that run on Ethereum Blockchain. You do not open an account or fill out an application form. Thus, Blockchain technology records verified transactions. One block is created to record the transaction, which gets closed and encrypted, whereas a new block gets created and stores information about the previous new block.

Thus, it is called ‘Blockchain.’ The disadvantage is we cannot change any block because it affects other blocks. However, the developers must have used the technology due to its advantages. Fraudsters cannot change information, and users have anonymity. No middleman is required because it is decentralized.

Transactions occur through DeFi wallets that provide a public and a private key to every user. You cannot use the wallet if you lose them. Virtual money is represented by tokens that represent a value. Send the token through your private key, which is accessible to the receiver via his own private key. However, it is not so easy.

It comes with risks where you may lose everything. Thus, trade small amounts in the beginning on a decentralized system and choose stablecoins not subjected to price movements.

Accessing DeFi

There are two methods to access DeFi: Through command-line programming and applications. You might feel uncomfortable with command-line programming if you are not a programmer. Thus, you may download and install related applications on your smartphone, laptop, computer, or tablet that provide an interface for transactions.

Uses of DeFi

1) Loan

You may get a loan and repay it through funding within a single transaction. The loaner will automatically get funds if you cannot repay the loan. These are called ‘flash loans’ where no lawyers are needed.

2) Stable Coins

Cryptocurrency is too volatile. So, some people get stablecoins whose value changes according to the change in a real-world currency like USD.

3) Lending

You may lend your crypto and earn every minute instead of every month. DeFi provides a savings account to store your crypto for future use at better interest.

4) E-wallets

You may create an e-wallet on your device without filling out any application form or opening an account and operate it independently. Moreover, DeFi is a decentralized system that lets you have control over your cryptocurrency.

Advantages Of DeFi

1) Flexibility

No need to get permitted or pay a lot for moving assets as it can be done at any time. Moreover, no need to enter personal details because DeFi is pseudonymous. It rather runs on open-source software handled by a developer community. Thus, none has to invest in administration services.

2) Transparency

All parties involved in the transaction can see its status at any time. Similarly, the two parties can directly negotiate with each other. DeFi has no geographic restrictions and you may access it with an active internet connection.

3) Autonomy

You can view information about any completed transaction, but none’s personal details, including yours, will be revealed. Similarly, there will be no central financial institution overseeing your ongoing transactions.

Disadvantages Of DeFi

1) DeFi Is Risky

DeFi is risky because newbies can fall prey to several bad applications and lose money within minutes. For instance, DeFi applications like Pizza and Hotdog crashed. Yam’s market capitalization reduced from $60 million to nothing within 30 minutes.

Similarly, you might lose money in the beginning because it is difficult to understand, and there will be no intermediary customer support because DeFi is decentralized.

2) Hacking

Your passwords and private keys might get hacked. An incorrect transaction cannot get reversed easily due to Blockchain. For instance, Bancor, another decentralized software like DeFi, was hacked in 2018. It froze the funds but lost $13.5 million. However, Charlie Lee, a computer scientist and the creator of Litecoin, questions whether the system remains decentralized if the funds are frozen.

3) Fraud

We do not need an external entity to commit fraud because DeFi users might disappear with investor’s money as their personal information is not stored. They might even lure the investors into investing like a Ponzi scheme. DeFi contributed to over 50% of cryptocurrency crimes in 2021.

4) Competition

Since DeFi is an open-source platform, programmers can copy or get influenced by the code and create their own software.

5) Attacks

DeFi is vulnerable to Front Running attacks where an attacker can start his own transaction during an ongoing transaction. Thus, that ongoing transaction might get reverted or may be termed as less profitable.

Conclusion

DeFi is a decentralized payment ecosystem that comes with various benefits and risks. However, it depends on the expertise of the user. Blockchain was made famous by Bitcoin and adopted by financial technologies like DeFi. Every country has yet to determine whether people using DeFi can be virtual asset providers according to the FATF guidelines.