8 Perks of Decentralized Finance
In 2020, the profitability of traditional financial instruments such as stocks and securities decreased. Investors started to seek something more lucrative, and part of them invested in Bitcoin. And that was for a reason — the crypto industry recovered way faster than the economy in general.
Others invested in DeFi — the domain of the crypto market that demonstrated the most rapid growth over the last 1.5 years:
The value proposition of DeFi is that it provides easier access to financial services and offers ways to invest and profit much faster than in traditional (centralized) finance. In this article, we will look at 8 parameters where DeFi beats CeFi and consider the challenges of decentralized finance. We will start with an overview of the concept of DeFi.
Comparing government-backed CeFi and blockchain-based DeFi
On a technical note, decentralized finance means that this financial domain is based on blockchain (mostly Ethereum’s). All operations such as borrowing and lending, insurance, asset management pass in a decentralized, often peer-to-peer way — with no intermediaries involved.
- One of the core values behind DeFi is that it gives access to financial services to anyone irrespective of their citizenship and location. In CeFi, finance is accessible only to the citizens who have no problems with the documents, have a good credit history, and so on. All operations here are tracked by banks and, hence, governments.
- Unlike CeFi, DeFi works without any intermediaries between a user and a service provider. Moreover, in DeFi, the governance and the rules by which a service operates are transparent — most DeFi protocols are open-source.
- In CeFi banks, a sum of money in your bank account isn’t really the funds you own — it’s just a guarantee that a bank will allow you to pay with or withdraw this sum when you want to. In DeFi, you have more control over your funds as you trade them right from your crypto wallet, which means no entity can freeze or limit your access to your money.
- DeFi is accessed through dApps that are available worldwide 24/7. There are no opening hours, no days off, no limitations to geolocation.
How is decentralized finance better than centralized one?
DeFi has gained enormous traction because it addresses many issues pertinent to CeFi. Here are the 8 points where decentralized finance beats the centralized one:
To use DeFi dApps, all you need is a computer with an internet connection and some cryptocurrency to start with. You don’t need to go to a bank to operate with your money — you don’t even need a bank account. Credit history is also something irrelevant here — if you want to take a loan, you simply leave collateral in another cryptocurrency, and you’re good to go.
2. Autonomous Operations
You access DeFi with your crypto wallet that only you have private keys to — unlike a bank account, no one can do anything to this money.
When you send a transaction, it is operated via a smart contract that works programmatically — with no human involved. Unlike in CeFi, no third party can anyhow manually affect what’s going on with money here.
If you are unbanked for some reason, with DeFi, you can use financial services with DeFi (in case you have access to a computer — many unbanked people live in areas with poor infrastructure). You can access DeFi no matter your age, location, citizenship, social status, credit history, or relationships with the authorities. If a local government restricted your access to banks, you can use DeFi as an alternative, and no government in the world is capable of blocking it.
Let’s say you’re applying for a loan in a bank. If a loan is small, the approval will take minutes. But if a loan is big, the approval may take days or even weeks. In DeFi, everything is working algorithmically — if you have a crypto wallet with enough collateral for a loan of a given size, you will get it in seconds.
In DeFi, you don’t have to disclose your name for any kind of operation. The Ethereum blockchain is, however, transparent — anyone can see how much money there is on your wallet at any moment, what transactions you made, etc. This makes Ethereum-based DeFi not as private as some would prefer; nevertheless, barely anyone can identify you based on your wallet address.
Most of the DeFi projects are open-source, which means they are ready that anyone can review their code and point out bugs or suspicious moments. And as already said, the blockchain saves publicly the records of all the transactions, hence you can always know what happens to the funds in the network.
7. Decentralized Finance Innovation
DeFi is a highly innovative segment where new tech solutions emerge every month. For instance, since Uniswap decentralized exchange emerged in 2018, the concept of liquidity pools was very novel for the market. By now, it’s already hard to imagine DeFi without pools, and many new advanced versions of them have been introduced since.
Since most of DeFi is built on Ethereum, you can’t trade Bitcoin or other off-Ethereum cryptocurrencies there. However, a Wrapped Bitcoin token was made on Ethereum to facilitate trading Bitcoin on the platform.
Same as with Bitcoin, DeFi allows tokenizing real-world assets and then trading them on Ethereum. The value is being transferred on the blockchain and gets the ability to be traded in a decentralized and secure way.
Main challenges for decentralized finance
- DeFi is yet to become a mature industry. Lack of regulation and the speed of evolution leave room for bugs in smart contracts and malicious activity. These two often lead to money losses for unlucky users.
- If something happens to your money in a bank, you can go there, ask what’s happening, and a bank officer will help you get your money back. In DeFi, there’s only a support team for each project, but they can’t do anything to your funds once sent due to the nature of blockchain.
In the past 1.5 years, DeFi has been one of the drivers for the whole crypto market growth. It offers easily accessible, transparent, and secure financial services that anyone can use. Although DeFi is very young and has a lot yet to establish, it already offers value that makes many migrate from CeFi. It’s not that anyone will start taking crypto loans in 3 years — but we expect the industry to establish legal frameworks, further grow and develop.