What is DeFi
DeFi or decentralised finance refer to financial services backed by blockchain technology that is not regulated via centralised intermediaries. DeFi has been lauded as the key to overcoming the outdated and inflexible traditional financial infrastructure. DeFi is expected to make ripples in areas of the financial sector such as: asset management and storage, loans, insurance.
DeFi applications enable users to partake in activities such as financial services similar to what traditional banks offer – interest, asset management, and transactional services. Unlike banking institutions, DeFi opens up financial opportunities to those without access to banks. DeFi is an open and global financial system that offers trading opportunities 24/7. Furthermore, users can participate with relatively more freedom in peer-to-peer (P2P) crypto loans on blockchain platforms.
About decentralised finance applications (dApp)
DeFi’s key feature is that there is no centralised intermediary where transactions will be vetted and processed. Users access DeFi platforms, known as decentralised finance applications (dApp), through decentralised applications which typically run on blockchain networks. The structure of DeFi allows participants to contribute to a project’s governance, development and evolution by voting on proposals to change the protocol. This provides users with complete autonomy, and without third party costs.
The difference between cryptocurrency projects and DeFi is that DeFi governance tokens are earned by participants through interaction and service provision to the protocol. For instance, posting collateral on a lending platform like Compound, or providing liquidity on a decentralised exchange such as UniSwap.
Taking Compound for example, the platform enables users to borrow cryptocurrencies and use predetermined “supported assets” as collateral for such loans. Running on an existing blockchain, the protocol mathematically determines how much a user can borrow based on the desired cryptocurrency, how much the borrower will need to post as collateral, as well as the interest rate to be paid.
Concerns about using DeFi
With this in mind, DeFi raises certain regulatory considerations. Financial regulators assume the presence of intermediaries, and such regulations are applied directly to these intermediaries as a means to regulate the financial markets and its activities. The logic and technology behind DeFi renders such regulations ineffective, which brings DeFi projects into regulatory crosshairs and amidst growing regulatory heat.
But what about DeFi’s potential?
DeFi is still up and rising, a powerhouse and disruptive force in the financial industry. Transaction services will see greater expansion due to the democratization of DeFi finance, which reduces the urgency for the supervision of trusted intermediaries. DeFi provides the transactional banking system more efficiency via transaction onboarding and market-based risk assessments. While it remains to be seen whether DeFi will become fully integrated into the financial transaction industry, it must be acknowledged that DeFi has numerous benefits to offer.
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