Decentralized finance or DeFi is a financial technology that is based on secure distributed ledgers, similar to the ones used by cryptocurrencies.
In the United States, the Federal Reserve and the Securities and Exchange Commission (SEC) set the rules for centralized financial institutions such as banks and brokerages, which consumers rely upon to gain direct access to financial and capital services. DeFi challenges the centralized financial system by enabling individuals to conduct peer-to-peer digital transactions.
DeFi eliminates the fees charged by banks and other financial institutions for using their services. Individuals keep their money in a secure digital wallet, can transfer funds in minutes, and can use DeFi from anywhere with an internet connection.
Decentralized finance eliminates middlemen by enabling merchants, individuals, and businesses to conduct financial transactions by using emerging technology. DeFi in 2023 employs connectivity, security protocols, software, and hardware advancements through peer-to-peer financial networks.
Individuals can trade, lend, and borrow using software that records and verifies financial transactions in distributed financial databases where there is an internet connection. A distributed database can be accessed from multiple locations as it collects and aggregates data from all the users and verifies it using a consensus mechanism.
Decentralized finance eliminates the need for a centralised finance model by allowing anyone, regardless of who or where they are, to use financial services anywhere. Through their trading services and personal wallets tailored to individuals. DeFi applications give users more control over their money.
Decentralized finance employs the same blockchain technology as cryptocurrencies. A blockchain is a distributed and secure ledger or database. dApps are applications that help handle transactions and run the blockchain.
Transactions are recorded in blockchain blocks and then they are verified by other users. If these verifiers agree on a transaction, the block is closed and encrypted, and a new block with information about the previous block is created.
The blocks are "chained" together by the information in each subsequent block, hence the name blockchain. Because the information in previous blocks cannot be changed without affecting subsequent blocks, there is no way to change a blockchain. This concept, along with other security protocols, contributes to the blockchain's secure nature.
One of the fundamental premises underlying DeFi is peer-to-peer (P2P) financial transactions. A P2P DeFi transaction takes place when two parties agree on themselves to exchange cryptocurrency for services or goods without the involvement of a third party.
P2P can meet an individual's loan needs in DeFi, and an algorithm will match peers who agree on the lender's terms, and a loan will be issued. Payments from P2P are made through a decentralised application, or dApp, and are recorded in the blockchain in the same way.
Using DeFi enables you to:
Anyone with an internet connection can use a DeFi platform, and transactions can take place anywhere in the world.
DeFi networks allow any two parties to directly negotiate interest rates and lend money.
Smart contracts published on a blockchain, as well as records of completed transactions, are open to the public but do not reveal your identity. Blockchains are immutable and cannot be altered.
DeFi platforms are not reliant on centralised financial institutions and are not vulnerable to adversity or bankruptcy. Much of this risk is mitigated by the decentralised nature of DeFi protocols.
Decentralized finance is always changing. It is unregulated, and its ecosystem is riddled with mishaps, hacks, and scams.
Current legislation is based on the distinct financial jurisdictions concept, each with its own set of laws and rules.
Who is in charge of investigating financial crimes that take place across borders, protocols, and DeFi apps? How rules are enforced and who would enforce the rules?
Other issues to consider are system stability, energy consumption, carbon footprint, system upgrades, system maintenance, and hardware failures.
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Disclaimer: Analytics Insight does not provide financial advice or guidance. Also note that the cryptocurrencies mentioned/listed on the website could potentially be scams, i.e. designed to induce you to invest financial resources that may be lost forever and not be recoverable once investments are made. You are responsible for conducting your own research (DYOR) before making any investments. Read more here.