A global and open financial system for the internet age, DeFi is an alternative to a system that's opaque, tightly controlled, and held together by decades-old infrastructure.
Your money is under your control and visible to you. In addition to giving you access to global markets, it gives you alternatives to your local currency and banking options.
With DeFi products, anyone with an internet connection can access financial services, and they're largely owned and maintained by their users. DeFi applications have so far processed tens of billions of dollars in crypto, and the amount is growing daily.
What is Decentralized Finance
Decentralized Finance is a financial system in which there’s no central authority or third parties who oversee asset movement by charging a fee. In a decentralized financial system, you are a bank.
There's a misconception that cryptocurrencies are defi. The truth is that cryptocurrencies like Bitcoin aren't defi, rather, Defi makes use of cryptocurrencies like Bitcoin for its transactions.
In decentralized finance, blockchain technology is used, which is a distributed, secure ledger upon which crypto currencies are built.
Examples of Decentralized Finance
A good example of a decentralized financial system is the Peer 2 Peer System popularly known as P2P. It’s the process where two people can carry out financial transactions in the absence of an intermediary or a third party.
Thus, this helps to remove escrow fees, KYC, and other complications and requirements that are associated with a centralized financial system before any transaction is processed.
Decentralized finance is the opposite of centralized finance, and to fully understand what decentralized finance means one needs to understand Centralized Finance.
What is a Centralized Finance
Centralized Finance is a kind of financial system where there’s a central authority or third parties whose sole aim is to make money (by charging a fee) to facilitate the movement of funds between parties.
According to Investopedia, they described Centralized finance as a financial system where your money is held by banks, corporation whose overarching goal is to make money.
In a centralized system, there’s no database distribution. A central authority controls the entire activity that goes on.
Example of a Centralized Finance.
Let's say you use your credit card to buy groceries at the store. An acquiring bank receives the fees from the merchant and sends them together with other information to the credit card network.
The network cancels the charges and contacts your bank for payment. Your bank authorizes the charge and relays the authorization to the network and back to the merchant through the acquiring bank.
Each link in the chain is compensated for its services, in general because retailers must cover the cost of allowing you to use credit and debit cards, and all other financial transactions have a fee.
For instance, loan applications can take days to be approved, and using bank services while traveling may not be possible.
How to Invest in Decentralized Finance
Investment in a decentralized financial system is not too far from how investment in a centralized system works. The only difference is the process and financial tools used.
For instance, you invest in a centralized system through bonds and shares in the stock market, you will need a Broker which is a centralized authority or third party, that will help connect you with the stock market, and takes a fee for that service because it’s sole aim is to make money.
But in a decentralized financial system such is eliminated, and with crypto wallets, dapps (applications), you can access the crypto market and invest in financial assets of your choice, represented as cryptocurrencies. You can also stake or borrow tokens in the defi system and receive rewards in the form of transaction fees.
Advantages of Decentralized Finance
- Takes away central authority or third party with the use of non-custodial crypto wallets you are able to retain custody of your assets.
- Transparency: There is transparency in the network because every transaction is broadcast to other users and verified by them. All network activity can be seen by any user because of this level of transparency.
- Voids mandatory requirements, KYC, and limitations, unlike in a centralized systerm where you have to provide your bio data, limitations. In a decentralized system these are absent.
Disadvantages of Decentralized Finance
- Private Keys - In decentralized finance you are given private keys to secure your wallets, thus, you are faced with the security of your assets, and should any loss occurs, you are solely responsible for it.
- Hackers - Attacks from hackers in the industry poses threat to the decentralized system. For instance, in a report from cnbc.com, where “White hat” hackers exploited Poly Network smart contract, stealing $600 million, luckily the funds were returned.
The purpose of a Decentralized financial system is to eliminate third parties or central authority, and it’s important to know that cryptocurrencies are not Defi rather they are assets used in Defi. Defi is the blockchain which is the underlying technology cryptocurrencies are built upon.