Decentralised Finance (DeFi) – The Twenty-First Century Way of Managing Your Finances
We know the world is changing – so are the rules of finance, and the way financial transactions are conducted. Cryptocurrencies and blockchain technology have certainly made a huge impact on the world of finance and the way we buy, sell, and invest. But it is not just cryptocurrencies and blockchain technology that are changing the rules of finance.
Many companies have embraced a new world of finance called decentralised finance. This growing trend is comprised of blockchain-enabled technologies that allow people to invest and transact more freely than ever before.
What is Decentralised Finance (DeFi)?
Decentralised Finance or DeFi is an umbrella term for an ecosystem of financial apps that are built using blockchain technology. In more technical terms, it refers to a modern initiative to develop a transparent, permissionless, and open-source financial services system that's easily and quickly accessible to everyone.
The most critical aspect of a DeFi system is that there's no central authority and no single individual or group of individuals have a major influence on the ecosystem. Instead, it's the users of the system that have complete control over their assets and they manage the network in a democratic way through decentralised apps (dApps) and peer-to-peer (P2P) technology.
One of the key advantages of DeFi is that it provides convenient access to financial services, particularly to those who currently don't have the privilege of using the conventional financial system. Apart from that, DeFi is built using a modular framework which means all the apps are interoperable. This will lead to the development of new financial markets, services, and products through blockchains.
Salient Characteristics of DeFi Ecosystem
- Built on decentralised technology like blockchain while data is stored across thousands of nodes
- Terms and conditions of interaction between users are specified by decentralised apps and smart contracts
- Any potential disputes are resolved by code and until then the user retains complete control over their funds
- There is no involvement of any central authority, influential individual or group, intermediary, or arbitrator
- Services are easily accessible to anyone anywhere at a more affordable price as compared to conventional banking
Key Advantages of Decentralised Finance (DeFi)
Talking about decentralised finance, many of you might be wondering why we need it at all. The traditional finance systems have been working well for decades, so is there really a need for a new ecosystem? Well, the answer is yes. For starters, we have gotten to this point because of continuous and persistent innovation. Stagnation in any market leads to deterioration of services over time and that's exactly why many conventional financial institutions including banks are now contributing to the DeFi movement. Here are some other major advantages of DeFi.
- Decentralisation of the Finance Market
The current model of financing involves a third party between the lender and the borrower which is usually a bank. This third party holds all the cards and can deny services to anyone along with dictating the terms and rules of the financial ecosystem. DeFi will eliminate the need for any central authority, intermediary, or regulatory body like a bank and lenders and borrowers will be able to interact with each other. This means that there will be no third-party influence or board of directors making major decisions on the users' part.
- Automated Dispute Resolution
The question arises that if there's no moderator between the interacting parties, who resolves the disputes which are bound to occur? The answer is quite simple - DeFi apps. They don't rely on any arbitrators and are perfectly capable of resolving potential disputes as per code specification. Over the course of resolution, the user will maintain complete control over their assets.
- More Affordable Finance Services
It is not exactly a secret that intermediaries like banks and financial institutions provide their services in exchange for a service fee. They also use the deposited funds to make investments on users' behalf to turn a profit. With decentralised finance, intermediaries will become redundant making financial services much more affordable. You will not be required to pay the service fees, commissions, and other hidden charges. While DeFi isn't completely free, it will far more economical as compared to conventional banking.
- No Single Point of Failure
It is often a case that your banking and finance services go down because the systems are not infallible. Generally, there's a single point of failure which means one glitch can bring the entire system down suspending access to financial services. On the other hand, decentralised finance relies on blockchain technology where there are no single points of failure. The data is stored on the blockchain which is spread across hundreds, even thousands, of nodes. This means that potential suspension or censorship of service is extremely unlikely.
- Access to Financial Services for Unbanked and Underbanked
Although we have come a long way in the twenty-first century to provide access to basic financial services to the common people, there are still millions out there who are either unbanked or underbanked, especially in underdeveloped countries. It means that they don't have access to the full range of financial services they need to be optimally productive and efficient in their lives. DeFi provides an easy and quick way for such people to have access to financial services since it's an open-source ecosystem with profit-making not being the primary objective. Being more affordable will also bolster the adoption of DeFi services in low-income communities.
- Quick and Easy System Deployment
When conventional financial systems need to be upgraded or updated, they need to suspend services for a few hours. That's not the case with decentralised finance. The system can be updated on the blockchain in real-time and can be developed in advance. This makes deployment far less complicated and highly secure.
How Does DeFi Work?
DeFi can be thought of as a parallel financial system that is not managed by central institutions such as banks. It is an emerging ecosystem for managing financial assets on the blockchain. The goal of the DeFi platforms is to provide alternatives to traditional banking allowing individuals to take control of their finances.
In a decentralised system, money can be converted into what's known as a stablecoin. These are digital replications of the euro, US dollar, or other fiat currencies. Since the value of the euro does not change that quickly, stablecoins provide stability in the cryptocurrency market. These stablecoins can then be lent out and interest can be generated on them.
Not That Different From Your Bank
With a savings account, you give your money to the bank to hold it for you. However, this money is not just sitting there but is used by the bank to grant new loans. While providing your money, you receive an interest rate.
In the decentralised system, interest rates are determined by supply and demand. With more demand than supply, you can earn high interest-like returns, all without any intermediaries. With DeFi lending and borrowing, control is given back to the people who decide how to use their money. Blockchain technology assures a high level of security and transparency and functions as a guarantee for both counterparties in the peer-to-peer lending system.
- Real-World Applications of DeFi
What we are talking about isn't just a theoretical exercise but there have been multiple successful real-world applications. Decentralised finance has gained relevance and popularity in relatively a short period of time and is now being embraced by conventional financial institutions because of its unique features. Following are some of the most popular use cases of DeFi.
- Decentralised Stablecoins
As most cryptocurrencies are volatile, decentralised stablecoins were introduced to solve the problem. These are the coins that offer all the advantages of a cryptocurrency without any high volatility. The value of a stablecoin is pegged or tied to another stable asset or group of assets like the US dollar. They can also be pegged to other assets like gold and silver. Tether, USDC, and DAI are some examples of stablecoins. Coinpanion's cautious and balanced portfolios also manage your risk by staking a major part of your capital in stablecoins.
- Decentralised Marketplaces
With the help of DeFi, many developers have also been able to offer decentralised marketplaces where you can buy and sell products and services without any involvement of a third party like Amazon. Unsurprisingly, one of the most popular applications has been decentralised exchange (DEX) platforms that allow users to trade their digital assets without any intermediary.
- Lending and Borrowing
Money or financial markets have also been one of the key applications of DeFi. Users can lend or borrow money or assets without any intermediary which makes it much quicker, convenient, and affordable to access required services. Lending protocols have been a major success as they allow a user to lend funds to another user through smart contracts which are used to define and enforce the terms and conditions of the agreement.
- Decentralisation of Synthetic Instruments
Synthetics are created to mimic the characteristics of financial instruments. Some of the common examples of synthetics are leverages and options. They are used to manage risk and handle cash flow associated with assets. Synthetics are also used to acquire gold as you don't actually get the physical asset but the documentation that signifies your ownership. Decentralised finance can be used to make synthetics more accessible to those who are unbanked. They would be in a much better position to invest in gold and other assets through DeFi.
Build Your DeFi Portfolio with Coinpanion
Coinpanion is one of the emerging players in the European DeFi market. We offer investments in portfolios featuring different risk profiles so you can find the right fit. Our cautious and balanced profiles stake a part of your capital in stablecoin and the remainder is invested in cryptocurrencies. This enables us to manage risk on your behalf so you can benefit from the upside of the cryptocurrencies while hedging your bets with your stablecoin investment. If you want to directly invest into the open and global financial system, you can also choose the Coinpanion DeFi Portfolio. This portfolio includes smart contract protocols, lending platforms and decentralised exchanges.
If you are looking to become a part of the DeFi movement, Coinpanion provides a simple and user-friendly entry into the market. All you need to do is create your account, deposit your funds, and choose your preferred portfolio.