What is DeFi?
DeFi (Decentralized Finance) refers to a collection of financial products and services that are built on top of blockchain networks. It is a brand-new monetary system that is being developed into an open and global financial system, as an alternative to the current traditional banking system. Its purpose is to create an open-source, permissionless, decentralized financial system that is accessible to everyone and eliminates the role of a central authority.
DeFi does not rely on central financial intermediaries like brokerages, exchanges, or banks. Instead, it uses smart contracts, which are self-executing contracts that come to fruition when specific conditions are met. In addition to this, DeFi allows for a peer-to-peer (P2P) system where users would maintain full control over their assets through DApps (Decentralized Apps).
An interesting aspect of DeFi is the ability to stack DApps together to maximize returns. DeFi protocols are modular, which means it opens up the possibility for protocols or DApps to be mixed and matched to unlock unique combos. Anyone can create, adapt, mix, link or build on an existing DeFi product without permission. This modular approach has given DeFi another name, Lego Money.
The potential use cases for DeFi include borrowing and lending money, trading cryptocurrencies in Decentralized Exchanges (DEX), earning returns through yield farming and liquidity mining, issuance of stablecoins, mortgages, and insurance.
Disruption to Banks
Decentralized finance is still in its infancy and has a long way to go. But the sector is evolving fast and gaining popularity and has already started to cause disruptions to the traditional banking and finance sector. DeFi, a sector that had a market cap of a few millions in 2017 is now rumoured to have a total market capitalization of at least $100 billion.
Today, the majority of the DeFi applications are built on Ethereum. But recently, more smart contract platforms like Cardano and Polkadot are gaining traction. And the number of DApps being built on different platforms is expected to explode. This has the potential to cause major changes in the banking and finance sector.
One of the main benefits of DeFi over banks is the easy access to financial services. Platforms like Cardano are being built with a focus on delivering robust financial services to the unbanked and underbanked. This could change the way we bank and interact with other assets. And an entirely new class of financial instruments may be introduced as the sector evolves.
DeFi Vs Banks: The Difference
1. Returns
One of the headline differences between DeFi and centralized banks is the potential returns on capital or savings that users can expect. While some of the banks provide interest rates as low as 0.1%, the average rate of return remains around 1-3% in the US. This is in stark contrast to returns that a DeFi investor can earn. While a lot of the DeFi protocols offer a return of around 6-8%, some offer even more. And the modular nature of DApps provides opportunities to earn even higher returns. From the perspective of financial returns, DeFi is far ahead of the banking and financial sector.
2. Innovation
Another major factor that is propelling DeFi ahead of the banking sector is its culture of innovation. While the banking sector is notoriously slow to adapt, DeFi is far ahead by introducing new protocols, DApps and other innovative features. This is not to say that banks haven’t delivered any major innovations. In the past few decades, banks have managed to add several value-added features like card payment technology, internet banking facilities, telephone banking and mobile apps.
3. Privacy
Decentralized lending works without either party having to provide information about themselves. Instead, the borrower will be providing a collateral that the lender will receive if the loan is not repaid on time. This is not how banks work. Banks need to know whether the borrower is likely to repay a loan before lending. This involves completing a credit check, calculating income and requiring a collateral. Banks also require their customers to complete a KYC (Know Your Customer) even before an account is opened.
4. Ease of Access
Another significant advantage for DeFi is the ease of access it provides to individuals that otherwise wouldn’t have access to any financial services. Since the traditional financial systems rely heavily on..........
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