Modern financial systems are surely going to change with the so-called Decentralized Finance Development (also known simply as DeFi development). This finance approach is based on blockchain, the technology used to secure cryptocurrency transactions. As such, DeFi, also referred to as Open Finance, does not make use of central financial intermediaries.
Being decentralized, DeFi doesn’t function like traditional banks, exchanges, or brokerages. Instead, this approach used smart contracts, which are quite common in cryptocurrencies such as Ethereum. The use of DeFi allows people to access more easily to some financial functions such as borrowing, lending, investing, trading, and more.
How intermediaries are removed by DeFi? This is possible through the so-called Distributed ledger technology (DLT). This technology allows all the entities (users) to hold a copy of the record of transactions (public ledger). Since intermediaries are eliminated, the aforementioned financial functions are performed with advantages such as:
- More reliability. All entities reach a consensus when a transaction is processed. Since DLT systems consist of a large number of nodes, the possibility of a single point of failure is inexistent. As a consequence, hacking the blockchain is almost impossible;
- More transparency. The public ledger information is available for all authorized DLT users. They also can access and verify the exchange encrypted data. Thus, all the transactions are transparent, which also allows detecting market manipulations in no time. Thus, the possibility of fraud is significantly reduced;
- Digitalization of assets. In this approach, the ownership of an asset is converted into a digital token on a blockchain. This digital representation of assets allows trading them on a digital platform. It also opens the possibility to interoperate with other decentralized applications;
- More security. Thanks to native encryption and hashing, DLT allows for a higher level of security of the data stored in the blockchain;
- Faster transactions. Since no intermediaries are involved, transactions are done more quickly;
- Lower costs. Likewise, the absence of intermediaries and automation in all the operations reduce operational cost drastically.
This technology is used in cryptocurrencies for value transfer. DeFi expands its use to other financial applications. For users, the most important part of DeFi is the security of their funds. Users have more control over their funds since they possess their private keys. This means that no one but the users themselves is responsible for the security of their funds. In the crypto sphere, this type of approach is referred to as non-custodial.
The Most Common DeFi Applications
Many specialists think that DeFi will shape the future of finance. As such, different applications have already emerged. Let’s review the most common.
The most common DeFi application is decentralized exchanges, which allow people to convert fiat money to crypto and vice versa. Exchanges allow users to trade their digital currencies directly with other users. No intermediary is involved.
These platforms allow users to lend (or borrow) funds by using smart contracts. This technology rescinds the need for an intermediary such as a bank to mediate the lending.
Tokens and Stablecoins
Tokens are digital assets that can increase the value of a DeFi application. They can also attract investors and increase capitalization. Likewise, stable coins are cryptocurrencies that are tied to non-crypto assets such as a fiat-money currency. This keeps their price stable.
Digital wallets are used to store digital assets securely. They also store information about the transactions with those funds. DeFi development allows creating digital wallets with private keys, which guarantee the highest level of security of all the stored data.