Nischal Shetty November 18, 2021 Cryptocurrencies and blockchain technology, as you may be aware, have literally taken the globe by storm. Cryptocurrencies such as bitcoin and ether are becoming more widely recognized as payment methods, and stablecoins like USD Coin (USDC) have made substantial progress toward becoming an asset with no future devaluation.
Simultaneously, the blockchain technology that underpins cryptocurrencies like bitcoin is on its way to providing a revolutionary financial system that runs parallel to – and is connected to – existing financial infrastructure. And this is accomplished using DeFi (Decentralized Finance), a blockchain-based type of finance that offers typical financial instruments and relies on smart contracts on blockchains instead of central financial intermediaries such as brokerages, exchanges, banks, etc.
DeFi apps essentially aim to provide traditional finance services (also known as Centralized Finance, or CeFi) in a permissionless, global, and transparent manner. DeFi is unique because it extends blockchain’s utility beyond simple asset transfer to more sophisticated financial applications.
Since 2020, DeFi has grown at an incredible rate, with billions of dollars already invested in the ecosystem. And the largest driving force behind this rise has been applications based on the Ethereum blockchain. From letting people lend and borrow funds to betting on price fluctuations in a variety of assets using derivatives, trading cryptocurrencies, and much more, DeFi has several applications. In this article, we will look at how decentralized finance will impact business financial services.
The basics of DeFi
Thanks to their increasing popularity and usage, many institutions have begun to facilitate the buying and selling of cryptocurrencies, offering custody services, and actively exploring new methods to get engaged in decentralized finance. Digital native businesses, venture capitalists, and individual investors are driving the recent surge in DeFi. The entry of traditional institutions into the DeFi market will undoubtedly be a turning point in the industry’s maturity and progress toward mainstream acceptance.
Smart contracts, which run on public blockchains, are an important part of DeFi. Smart contracts are code stored on a blockchain platform that conducts a series of preset activities on their own, usually in accordance with the conditions of a contract, without the need for a third party. These smart contracts are immutable once they’ve been implemented, and the source code and transactions facilitated by them are recorded on the blockchain for everyone to see.
A DeFi service can be any service that can be incorporated into a smart contract, and all smart contracts can be analyzed and verified. In addition, all user interactions can be tracked, making DeFi the first fully transparent financial system.
A smart contract may, for example, be configured to exchange a particular amount of cash between two counterparties. If the smart contract code confirms that each counterparty has given the appropriate money, the transaction will be executed, removing the requirement for third parties to assist the transaction. A set of smart contracts can work together to perform various tasks, and many applications rely on numerous smart contracts that are connected together.
Transforming business financial services through DeFi
As we saw above, the primary objective of decentralized finance is to change the world’s present centralized financial infrastructure by establishing a decentralized internet-based architecture that depends on open-source protocols rather than traditional financial intermediaries. By providing conventional financial institutions with several development options, DeFi essentially aims to help them improve their operations and services. And the way institutions react to this new type of decentralized financial intermediation will have long-term implications for their position in the digital economy. Here’s how DeFi will transform financial services.
- Borderless access for everyone
In essence, DeFi aims to provide a worldwide, decentralized alternative to every financial service now available, such as insurance, savings, and loans. DeFi’s primary goal is to offer financial services to the world’s 1.7 billion unbanked individuals.
And this is possible because DeFi is borderless. These financial services are available to anybody with a smartphone and internet connection in any part of the world. For the impoverished and unbanked, this will revolutionize banking. They can invest anywhere in the world in anything with just the touch of a button.
By providing open access for all, DeFi empowers individuals and businesses to maintain greater control over their assets and gives them the financial freedom to select how to invest their money without relying on any intermediary. DeFi is also censorship-resistant, making it immune from government intervention.
Furthermore, sending money across borders is extremely costly under the existing system. DeFi eliminates the need for costly intermediaries, allowing for better interest rates and lower expenses, while also democratizing banking systems.
- Tokenization
Tokenization is another characteristic that is at the heart of decentralized finance. Tokenization is the process of turning a valuable item into a digital token that can be used in a blockchain application. Anyone with access to the DeFi application may trade, borrow against, sell, invest in, and exchange that value once it is available on distributed ledger technology.
This will revolutionize asset trading throughout the world, opening up new marketplaces and possibilities for traders. As more institutions join the blockchain ecosystem and the tokenization of financial assets such as derivatives and securities matures, smart contract-based decentralized apps have the potential to function as mediators between them.
Furthermore, by allowing traditionally illiquid assets to be represented as tradable fractionalized tokens on a public blockchain, the tokenization of real-world assets on public blockchains would unlock liquidity for businesses. On DeFi protocols, these tokens can subsequently be used as collateral or added to investment pools.
- Lending and borrowing platforms
Lending markets are a prominent type of DeFi that connects borrowers with cryptocurrency lenders. Instead of banks investing and lending money, smart contracts will handle deposits, pay interest, and lend crypto depending on market-defined conditions. Compound and Aave are two prominent examples of DeFi based peer-to-peer lending and borrowing platforms.
While these are the most prominent ways in which DeFi will transform business financial services, DeFi applications can also be found in other areas like decentralized exchanges, stablecoins, prediction markets, yield farming, liquidity mining, etc. Companies, financial institutions, and individuals will have a lot more choices to conduct business outside of the conventional banking system, thanks to each of these capabilities.
The future of DeFi
Given how DeFi creates a better and more accessible financial system, services previously held by banks and financial institutions are certainly changing. And as the number of participants and the volume of capital invested in these protocols grows, institutional interest in DeFi will undoubtedly grow.
Businesses need to be aware that, like any other emerging technology or invention, DeFi has several challenges to overcome. Regulatory ambiguity, scalability, security and technological hazards, governance of decentralized apps, and technology are just a few concerns. However, DeFi’s ability to transform the world is unquestionable, and overcoming these obstacles will be critical to its ongoing growth.
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