Many people still do not understand how decentralized finance (DeFi) works but its effects are definitely going to change how the banking world works by disrupting the very basis of how transactions are done.
DeFi is an umbrella term for a financial system that functions without third-party intermediaries like banks — one that is geared toward disrupting the traditional finance world. Inspired by blockchain technology, DeFi is referred to as financial applications built on blockchain technologies.
“(DeFi) can offer improved transparency and more robust security while replacing many of the current outdated processes which can lead to a truly decentralized and democratized financial ecosystem,” said Peter Wall, CEO of global crypto mining company Argo Blockchain, in a Forbes interview.
DeFi was born from the idea of building an ecosystem that can allow cryptocurrencies such as Bitcoin to do normal everyday transactions without going through the existing regulators, said Tom Schmidt, general partner at Dragonfly Capital, a venture firm that focuses on the crypto space.
“A lot of things that are happening in DeFi right now were being already discussed five years ago. But if you don’t have the users and the liquidity, you really don’t have a market firming,” Schmidt said during a Bloomberg podcast interview.
DeFi apps operate without a central service exercising control over the entire system the way traditional banks and stocks exchanges do.
DeFi has already gained traction in borrowing, lending and trading specifically, and is revolutionizing financial services, with more improvements likely on the way, according to Andrew Kiguel, CEO and founder of Tokens.com.
Here are seven things you need to know about DeFi.
It’s not immune to risk
Decentralized finance is not immune to risk but many people have been participating in it without understanding this. Serial U.S. entrepreneur Mark Cuban lost money when a coin known as Titanium crashed to zero in a day.
“I got hit like everyone else,” tweeted Cuban, who is an owner of the Dallas Mavericks and an investor on ABC’s “Shark Tank.”
Fraudsters are targeting DeFi
Can help users lend out crypto
Through DeFi lending, users can lend cryptocurrency like a traditional bank lends fiat currency, and earn interest as a lender. Borrowing and lending are among the most common use cases for DeFi applications.
Could allow 24/7 trading in financial assets
Eventually, through a DeFi mechanism, markets will be able to allow 24/7 trading without the interference of brokers like we saw when Robinhood halted retail trading in GameStop, BlackBerry and Nokia in January, prohibiting its clients from buying or selling.
It has yet to prove it’s a true improvement
Currently, the usability is non-intuitive, risk-adjusted pricing is non-existent and the liquidity cannot compete with the centralized alternatives. Nevertheless, crypto enthusiasts such as Tom Schmidt are bullish, saying that these are issues of a nascent ecosystem.
Listen to GHOGH with Jamarlin Martin | Episode 74: Jamarlin Martin Jamarlin returns for a new season of the GHOGH podcast to discuss Bitcoin, bubbles, and Biden. He talks about the risk factors for Bitcoin as an investment asset including origin risk, speculative market structure, regulatory, and environment. Are broader financial markets in a massive speculative bubble?
Ethereum leads the pack
While it may be difficult to determine which protocols and applications will get the most usage long-term, currently the advanced decentralization, programmatic flexibility and the enthusiastic developer base give Ethereum the lead. Other DeFi dApps include EOS, Tron and IOST.
Has potential to expand financial access to Black people
DeFi has the potential to expand financial access in Black communities and communities of color, according to Nahja Roberts, CEO of Crypto Blockchain Plug. She points out that in most Black communities, the right access to savings is limited and predatory lending is at an all-time high.
“DeFi opens doors to opportunities in our community,” she said. “It also offers alternatives that do not allow anyone to get in between our community and their capital.”