What is decentralized finance, and how it influences today’s financial system?

How DeFi Revolutionizes the Financial Sector: Explaining all Benefits for Businesses

DeFi became a large opening of recent years and one of the most disruptive blockchain technologies for today. In 2021, cryptocurrencies reach new heights, companies actively adopt crypto payments, while miners go all-in and invest in graphic cards to skyrocket their profits. Even though digital currency price charts remind us of a roller coaster in recent months, the niche is actively progressing and opening new horizons.

DeFi is one of the most rapidly developing subsectors in the cryptocurrency ecosystem. Ethereum-based finance platforms have been gaining momentum for over a year. Since May 2020, the DeFi sector experienced an increase by 65 times with a total value locked (TVL) of $65,2 billion. Uniswap, a decentralized financial marketplace, launched its UNI token in September 2020 at a price of $0,48 per token. A year later, its price reached $22,08 per token and Uniswap became a renowned DeFi marketplace.

In today’s article, OpenGeeksLab will figure out what DeFi is, discover differences between DeFi and traditional financial systems, and examine its benefits for regular consumers and businesses. Let’s roll.

What Does DeFi Mean?

What is DeFi: explaining the idea and technologies behind the concept.

DeFi stands for decentralized finances. It’s an umbrella term for financial blockchain services. DeFi platforms allow users to perform financial operations, transactions, borrow money, trade assets, and more, but all transactions don’t require a mediator represented by brick-and-mortar banks.

To understand what is DeFi in cryptocurrency you have to be familiar with smart contracts. The whole decentralized finance sector is based on smart contracts blockchains, mainly Ethereum, the world’s second-largest cryptocurrency. Smart contracts are basically replacing banks. While with traditional finances banks are facilitators that make sure that all liabilities are fulfilled, smart contracts do the same thing but automatically. Cutting out all intermediaries between benefactors and beneficiaries is the main advantage of DeFi.

How DeFi Changes Financial World

What changes decentralized finance brings to the financial world.

As it comes clear, DeFi is a revolutionary technology that will soon change our financial system as we know it today. This niche brings a ton of new opportunities for blockchain startups and regular consumers. To understand what DeFi means for the modern financial world we’ll get through several examples.

1. Exchange Platforms

One of the most prominent examples of DeFi products is decentralized exchange platforms. The idea behind decentralized exchange lies in peer-to-peer protocols. Let’s imagine that you want to trade Ethereum for XRP. When using platforms like Binance or Coinbase, you’re relying on a third-party platform. What distinguishes decentralized services is that they use smart protocols for transactions. Uniswap pools all tokens to smart contracts and transfers funds to users when all contract terms are met.

2. Lending and Depositing Platforms

Another mentionable use case of DeFi is lending and depositing platforms. DeFi protocols like Aave, MakerDAO, Alchemix, and others allow financial entities to take loans, deposit digital coins, and exchange it. For example, Aave offers users to deposit around 30 different cryptocurrencies including stablecoins (U.S. dollar-backed currencies that are less volatile compared to conventional ones). Just as a traditional bank, this platform offers different APYs (annual percentage yield) for different tokens.

It may be confusing how decentralized platforms deal with lending money if both parties don’t know each other’s personal information. Banks check borrowers’ credit history and current financial status to make sure that their loan will be paid off. In their turn, DeFi platforms oblige borrowers to put reserve funds that will be transferred to lenders if loans won’t be repaid.

3. Crypto-Based Synthetic Assets

Synthetic crypto assets is an $8 billion DeFi niche that allows trading synthetic cryptocurrencies or market shares on various P2P platforms. Crypto-based synthetic assets give users access to a range of different assets without actually holding the underlying asset. Let’s consider Abra, a decentralized investments platform. If the user buys Apple shares worth $1,000 in BTC, the platform will add or subtract BTC from the investor’s account depending on Apple’s stock market position. Other popular platforms dealing with synthetic assets are UMA and Synthetix.

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4. Automated Investing Platforms

Furthermore, the DeFi market brings automated platforms for crypto investors. Bloq, a blockchain infrastructure company, recently launched Vesper, a tool that automates DeFi transactions. The whole concept of the tool closely resembles mutual funds but in the blockchain. Yearn Finance is another suite of DeFi tools for decentralized lending, yield farming, and Ethereum-based insurance. Investors mustn’t be experts of the protocol, so Yearn Finance is a suitable option for passive investing.

5. Open Money Marketplaces

Finally, open money marketplaces are killer apps for decentralized investors and borrowers. Compound.finance is a bright example of such a marketplace. Lenders invest their money in a shared liquidity pool from which borrowers can take money. The liquidity pool is a series of smart contracts that finds proper assets to every borrower. It is not a bank and platforms don’t act as intermediaries. When contracts take effect, they are automatically assigned to both lender and borrower and expire when all liabilities are fulfilled.

DeFi is a rather young and growing field. As for now, it already offers a wide variety of solutions for investors and regular users of financial services. However, the opportunities for this niche are unlimited, so we’ll definitely see new ideas over time.

Why DeFi is Better Than Traditional Finances

How DeFi stands out from modern financial technologies.

It is a common cause that the more nodes are excluded from any process, the more reliable and transparent it becomes. This statement describes all DeFi benefits in a nutshell. Excluding banks, payment gateways, and other mediators from all financial processes makes transactions faster, easier, and more straightaway for all parties. Still, let’s figure out why DeFi services are better than the conventional financial industry.

1. Smart Contracts as a Single Source of Truth

Each financial establishment declares its own rules and regulations regarding payments processing, insurance, lending, and other operations. When dealing with several institutions, you have to figure out regulations and deal with a lot of bureaucracy on your own.

Decentralized financial platforms declare all rules with code. Smart contracts don’t require you to analyze 30-page documents and sign them dozens of times. Instead, smart contracts are filled automatically based on the actions you perform on the platform, and don’t require human interference until the expiration of your contract. Thus, Algorand’s Smart Contracts (ASC1) enable users to do margin trading. Traders borrow money via smart contracts and undertake to return funds or else their collateral will burn.

2. Transparent Financial Operations

Financial institutions don’t disclose their transaction processing algorithms. As a result of overcomplicated know your client (KYC) procedures your transaction can be delayed or even blocked because it may look suspicious to financial officers. Besides, there’s always a chance of a system malfunction. If your funds will be transferred to the wrong receiver through the bank’s mistake, you’ll have a hard time proving their fault.

In their turn, DeFi systems are built with open-source code that is available for everyone. Users can examine the code and decide whether they consider it safe enough to carry out financial operations via this software. Besides, blockchain transactions are available for the public too. No worries, users can only see encrypted IDs of a sender and a receiver. All transactions aren’t linked with real entities and can’t deanonymize any of the parties.

3. Financial Operations Without Borders

Another significant drawback of conventional financial operations is their location-based limitations. Because of taxation standards and the inability to trace spendings in other countries, banks may restrict access to some of their services, disable mobile banking, or provide additional regulations while clients are abroad.

DeFi platforms can be accessed from any point in the world. With just an Internet connection, you can exchange tokens, pay with them for your purchases, and send them to other crypto wallets. Blockchain has no unified regulator, thus no one forbids you to operate with your money from anywhere you need. However, It doesn’t mean that you can freely move your money to a credit card after selling cryptocurrencies. All credit card operations are still checked by your bank, so you’ll probably have to explain the money’s origins.

4. Financial Services Accessible for Everyone

Modern banks have a range of regulations for those who want to open an account. For instance, clients can’t open a bank account in a foreign institution without additional papers and permissions. Besides, it’s almost impossible to borrow money from banks if you have a bad credit rating. In 2020, almost 21% of adult Americans have been turned down for credit.

DeFi services significantly simplify organizational processes. Today, anyone can create a cryptocurrency wallet and interact with blockchain-based financial platforms. Additionally, lending platforms don’t use credit rankings. Instead, they oblige users to provide collateral that will be issued in case if users don’t comply with the smart contract’s requirements. Such accessibility attracts users that have trouble with lending and those who don’t tolerate bureaucracy.

5. Seamless International Payments

International transactions, as they are now, create a lot of inconveniences for physical and legal entities. A common SWIFT transfer may take from one to four business days to reach the receiver’s account. Besides, the SWIFT fee may be quite expensive if you use this system on a regular basis. What’s more, banks may ask beneficiaries to verify income from a company with a contract that ensures the legality of received money.

Decentralized financial services are a one-stop shop for international payments. Tokens can be transferred in a matter of seconds at zero cost. No one will ask you for supporting documents until you trade digital coins for fiat money and try to transfer it to your credit card. However, even global electronic fund transfer companies already adopt cryptocurrencies. Thus, Visa now accepts transactions with USD Coins (USDC) on Ethereum. This fact indicates that traditional financial institutions have nothing else to do but to accept the new reality.

6. Data Safety

Sensitive data is a scourge of 21 century. When using payment gateways or even entrusting private data to financial institutions, users hardly inquire about how third parties handle their sensitive data. In the modern world, it has become a common thing that companies suffer from massive data leaks from time to time. As for 2021, the biggest data breach compromised more than 3 million data records. You never know what algorithms stand behind payment gateways that you use to buy clothes on some unpopular website. Even PCI DSS regulations can’t guarantee full protection against fraud and vulnerabilities.

DeFi economy protocols, on the other hand, have a decentralized architecture. DeFi systems limit hackers’ abilities because every module of the system is distributed between multiple users, making it impossible to infiltrate the system. Additionally, blockchain developers are often confident about the safety of their protocols and offer large sums of money to whitehats who will identify critical bugs and vulnerabilities. However, it doesn’t mean that your funds are always safe in the blockchain. Fraudsters, counting on users’ carelessness, can use social engineering and phishing to gain access to their crypto wallets.

A DeFi ecosystem has considerable advantages over conventional financial institutions. The only thing that separates decentralized financial services from more innovations is a lack of investments. Tech giants are reluctant to adopt blockchain solutions, while blockchain startups don’t have enough resources to develop large-scale projects. But we strongly believe that with a growing DeFi market this situation will change anytime soon.

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The DeFi’s Benefits for Small and Mid-Sized Businesses

What advantages DeFi brings to small and mid-sized enterprises.

Regular consumers aren’t the only ones who can benefit from DeFi. Small and mid-sized enterprises can find different applications for decentralized finances in their workflow. Let’s discover what benefits the DeFi economy brings to businesses.

1. Decentralized Crediting

Funding is a primary thing for startups and small businesses. Unfortunately, investors may reject some innovative ideas and leave them with no investments. DeFi services can lend money to confident startup owners that are ready to provide collateral for the borrowing. In case the project takes off, entrepreneurs will repay their debt and have an MVP version of their product to erase investors’ doubts.

2. Staying on Top of Trends

An early blockchain adoption allows you to promote your product for new markets and attract new audiences. Besides, a new crypto payment method helps you to expand your client base with an audience that may not have the ability to use other payment methods.

Even though a lot of people are uncommon with crypto today, eventually, companies will use crypto payments more often. That’s why it’s better to integrate them now, while everyone else is overlooking this trend. Simply put, with blockchain, you’ll be one step ahead of your competitors.

3. Stablecoins

Another cryptocurrencies’ problem is Bitcoin’s and altcoins’ volatility. It’s highly possible that Bitcoin’s exchange rate will decrease again. If you aren’t a big fan of heart attacks, it’s better to invest in stablecoins. Stablecoins are tokens with an exchange rate pegged to some real-world commodity. For example, the price of a USDC token depends on the price of the U.S. dollar. It’s safer to keep your funds in stablecoins to avoid becoming a victim of exchange rate fluctuation.

4. Innovative Savings

DeFi brought a new way for businesses to manage their investments and savings. Blockchain-based lending apps allow companies to earn interest for locking their assets in a specific lending protocol. This resulted in the appearance of various lending platforms that provide attractive interest rates for customers. Cream Finance, Aave, Fulcrum are some of the most well-known decentralized lending services out there.

Turn DeFi’s Potential to Your Advantage

During the last year, the DeFi ecosystem changed the blockchain world drastically. Such rapid growth of the sector indicates the importance and relevance of this technology in today’s market. As the adoption of cryptocurrencies becomes more widespread, the DeFi sector will only expand more. At OpenGeeksLab, we are keeping our fingers on DeFi’s pulse and willing to contribute to the financial revolution. Our blockchain solutions accelerate financial processes and deliver more privacy to our users. Feel free to contact us to discuss your DeFi project!

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