Welcome to whiteboard programming where we simplify programming with easy to understand whiteboard videos and today I’ll be sharing with you What Is DeFi or Decentralized Finance and how it is going to change how financial firms work worldwide … so let’s get started! First, what is Defi or decentralized finance?
Well, DeFi is a global, peer-to-peer system of storing and transferring assets without the structure, restriction, and costs of a traditional centralized banking system. In fact, many bankers believe that DeFi can do everything a bank can do, only faster and more transparently….
and this all is done through implementing digital smart contracts on public ledger blockchains like Ethereum. The need for DeFi comes from the fact that financial services are not available to everyone around the world.
Almost 1.7 billion people all around the world have no means or access to financial services and equally, financial institutes can also NOT provide the necessary infrastructure to make money more accessible to people and on the same note, the existing infrastructure is huge, but it does lack when it comes to reaching everyone out there. With decentralization, the current infrastructure failures can be solved as it has the potential to remove the failure points in the existing infrastructure and ensures that the records can be stored and shared among different nodes across the network.
Also, with decentralization, one can transact on a peer-to-peer network without any centralized authority. I know what you’re thinking, Can’t the existing financial infrastructures like Banks work in any way? Well, for the current infrastructure to work, there is an over-dependence on the centralized authority as without its governance, rules, regulations, and reach, it is impossible to implement in some areas, especially in places where wealth generation and distribution are less or inadequate.
Also, centralized authority holds the power to delete accounts or block them if they deem so, and here, censorship might also be needed in some cases, but in reality, in most cases, it is restrictive and makes the end-users suffer. Another key element of the DeFi is the decentralized apps (or dApps).
The Decentralized apps enable the financial institutes to create functional apps on the public blockchain and ensure that anyone can interact with them with a minimal cost per interaction. Next, let’s discuss, How does DeFi Works Well, fundamentally, DeFi works off a public decentralized blockchain network, stablecoins and DeFi apps (or decentralized apps) Here, blockchains continuously collect chunks of data and links them, because if this, the past transactions are immutably and unbreakably documented. As each transaction here is publicly verified by everyday users, once it goes on the chain, it can not be changed. We all know that the decentralized nature of blockchain makes it more secure than any other alternatives that depend on one centralized owner or authority like banks, corporations, and governments.
This technology enables the tracking of singular pieces of data like cryptocurrency payments so financial transactions can be verified and traced back to their owners, giving it the verifiable value that can be used even more securely than fiat currencies.
Now, let’s talk about some applications of DeFi and where all can it be applied 1. Remittance Market Solution The most significant impact of DeFi would be on the remittance market. The market surrounds the idea of sending millions of dollars across the borders by workers that are working in foreign countries. These workers go through a lot of problems with sending the money and one of their biggest problems is the fee that they have to pay to complete the transaction. This fee is usually between 6-24% and depends on your individual use case too and if you’re some who is already earning less, then you would have a lot lesser funds to send.
With Decentralized Finance or DeFi, it will be possible to cut the cost associated with sending money by at least 50% or more.
2. Loans Now, Decentralized finance can also be proven very helpful when it comes to loan management. In general, the loan industry is very dependent on having access to banking. If you do not have access to banking or a similar service, you cannot take a loan.
This means that you also need to have a proper credit score or a banking record that you can show to prove your eligibility for the loan.
With DeFi, a platform can address the connectivity issues among lenders and borrowers. These Defi loans enable users to lend their crypto to someone else and earn interest on the loan. As banks always have been utilizing this service to the fullest, now, it’s our time, as in the world of Defi, anyone can become a lender and the easiest way to do so is through lending pools. 3.
Stablecoins While price volatility is common with cryptocurrencies still in their infancy, a number of solutions have been developed to combat the problem. Stablecoins limit price fluctuations by tracking the price of other assets. Their value is often pegged to traditional fiat currencies such as the US dollar, and they can be thought of as a type of synthetic asset. Stablecoins are designed to be worth the same as the asset they’re pegged to, and they’re not restricted to fiat currencies. In fact, when it comes to uses, stablecoins have many, They’re often used for decentralized finance activities like liquidity mining, lending, and borrowing.
Stablecoins can also be used to earn yield — currencies like aDAI pay interest on DAI deposited in Aave (aDAI is available in Monolith, among others).
Moreover, stablecoins can be used as an alternative to fiat currencies. Transactions are settled on the blockchain, so they’re often faster and more affordable than fiat money. Next, lets talk about Traditional vs. Decentralized Finance (DeFi) What makes traditional and decentralized finance (DeFi) different?
The main difference is how they work. Traditional financial systems work with centralization, and it brings inefficiency and insecurity as if the central authority fails, your money is lost. We all have heard about various security risks in our current traditional financial system and the main source of this is cybercrime. Most of the transactions are at risk of getting hacked and all of these bring in both financial and data risks. DeFi, on the other hand, ensures that the issues are fixed to a certain extent.
At the core, DeFi uses a public blockchain, which means that it doesn’t rely on a centralized system or entity. It can work without the need for proper infrastructure. Further, the two differ primarily on three points 1. In decentralized finance, a public blockchain acts as the trusted source, governing all operations in the financial sector. In contrast, public governance, which entails laws and licensed financial institutions, acts as the trusted source, governing all operations in traditional finance.
2. Decentralized finance continues to gain traction in part because it is more open and transparent than traditional finance. The lack of barriers to entry means anybody with programming skills can take part in building financial services and tools on top of public blockchains. 3. In contrast, cumbersome barriers to entry have made it improbable for the traditional finance system to embrace the emerging trend.
The fact that one must obtain proper licenses and authorization from regulators has limited innovation around the traditional finance systems. A DeFi example includes Rainier AG. It is an independent Swiss asset management firm building blockchain ecosystem and is developing an ecosystem to bring fiat money and cryptocurrencies together as a single integrated financial tool.
Further, let’s talk about Pros and Cons of DeFi Well, there are some major advantages of using DeFi, including cost, speed, and security. Anyone with an internet connection who has the access to blockchains and cryptocurrencies are able to make trades and move their assets whenever they want without having to wait on bank transfers or pay bank fees.
In a nutshell, DeFi is fast. Here, the blockchain also is updated as soon as a transaction is made, and interest rates are updated multiple times in one minute.
Further, as the open nature of DeFi means that every single transaction can be seen by the public, it makes it very hard to steal cryptocurrency because of how the blockchain logs transactions. You can also invest on securities markets and conduct peer-to-peer activities. For example, BitPay can be used to make purchases for physical goods that are typically paid for in dollars by transferring crypto into cash.
The economic impact of Covid-19 and how banks responded revealed another potential benefit of DeFi. In response to the pandemic’s recession, some central banks slashed interest rates to maintain consumer spending and protect the economy.
However, that cut the effective net worth of savers. Under a DeFi regime, a central bank would have a much more difficult – if not impossible – task to manipulate the value of its currency. In other words, DeFi enables users to guard the value of their assets from central bank manipulation.
Now, you must be thinking, that DeFi is AWESOME, right? Well, not everything is positive when it comes to decentralized finance. Some challenges need to be covered to make it more viable to the different governments and organizations out there. One of the biggest challenges that DeFi has to encounter is the adoption rates as even though we all are connected through the Internet, we rarely have public awareness regarding the DeFi. Not many people know about DeFi, and that can impact its use rate.
In fact, to your surprise, there are very few people that even know about crypto.
I know what you’re saying, but the reality is that crypto gained its popularity during the bitcoin price rise, and still, it is nowhere near the “internet” or other more popular technologies out there. Even though public blockchains are technically capable of accepting every one of us out there, but it lacks the bandwidth to work efficiently. In comparison, companies like Visa can process a huge number of transactions per second. Further, DeFi users are not able to guard the value of their assets from market gyrations.
The value here fluctuates frequently and sometimes extremely. Ethereum transaction rates also fluctuate, so trading could potentially become expensive. Further, dapps are a relatively new technology and weaknesses or liabilities may yet emerge. In addition, there is also an array of potential tax implications that come with purchasing, trading, and investing via DeFi, but lets talk about it in some other video. Finally, the shape of emerging policies and regulatory schemes has yet to be determined.
In particular, it remains to be seen how regulators will respond to stablecoins coexisting with central bank digital currencies… As a key takeaway, I’d like you to remember that DeFi is globalized and permissionless, meaning anyone anywhere has access to funds and other assets at any time, without incurring penalties or fees levied by banks or other traditional financial institutions.
Widespread use of DeFi could speed the transition to a cashless society and to an extent, cybercrimes might also be reduced as blockchain technology tracks and secures each transaction meaning it would require a massive coordinated cyber attack to disrupt the chain and this is what exactly makes an attack highly improbable.
With that, I hope this video was helpful to you and served value, if you love my content, feel free to smash that like button and if you haven’t already subscribed to channel, please do as it keeps me motivated and helps me create more content like this for you!