In this article :
1.What is DeFi?
2. How does DeFi works? 3. Scope of DeFi
1. What is DeFi ?
AI is no longer just an option in finance, DeFi is taking over the financial industry. DeFi stands for ‘Decentralised Finance’. DeFi connects the lender and the borrower directly with each other without the need of a third party. It uses blockchain technology, cryptography and smart contracts to process transactions.
DeFi is open for all, you do not need social security number, proof of address or KYC documents for making transactions in DeFi.
2. How does DeFi works?
DeFi is all based on trust or we can say “smart contracts”. Suppose Elon Musk has to sell a Tesla to a customer for say 3 Bitcoins. but he ain’t sure if the customer will pay on time. Also, the customer ain’t sure if Elon will send the car on time so in the traditional or centralized system of finance (CeFi) they both have to find a middleman to proceed with the deal. This will cost them two most important assets - ‘time’ and ‘money! In DeFi, the problem of trust is solved by replacing the middleman with a ‘smart contract’.
In DeFi, the deal will automatically get processed when Elon Musk will enter a digitalized deed to the smart contract and the customer will also send the 3 Bitcoins to the smart contract.
• How does a smart contract works?
A smart contract is basically a program entered in the blockchain which automatically executes a deal when all the predetermined conditions entered in the contract in the form of code are met.
This solves the ‘problem of trust’ as the deal is executed only when conditions from both sides are met. The transaction is recorded in a public blockchain which can’t be altered, due to this the ownership of Tesla cannot be questioned.
Suppose, Adam wants To buy a Tesla but he doesn’t have enough money. In the traditional or centralized finance system (CeFi) Adam has to go to the bank to take a loan and keep collateral security (in this case the Tesla itself is collateral) with the bank. In case he ain’t able to repay the loan amount with interest on time his Tesla will be seized by the bank. Also, taking a loan would require him to submit all his KYC documents, etc.
• How to take a Loan using DeFi?
However, in DeFi, if Adam wants to take a loan to buy a Tesla, he has to bring cryptocurrency as collateral and lock it in the smart contract called a Collateralized Debt Position (CDP). Borrowing money in DeFi will require Adam to submit an overcollateralized security or we can say that the value of cryptocurrency given as collateral will be equal to or more than the value of the Tesla that Adam purchased.
3. What is the scope of DeFi?
DeFi has the power to revolutionize the existing centralized financial system. Its scope is much wider than just taking/ giving loans and facilitating trade. It can help in crowdfunding which refers to raising small funds for projects through the internet. DeFi can also enable small farmers and villagers to take loans without the necessary documents like KYC, as getting loans from commercial banks can be difficult for poor people.
Many successful startups have been launched in the DeFi field like Makerdao, Compound, Aave, Uniswap, etc.
It is an Ethereum based protocol that helps to provide loans in DAI currency without the help of a third party. DAI is a stable coin cryptocurrency whose value always fluctuates close to the value of the US dollar. It is the first and one-of-a-kind cryptocurrency that is stable. Makerdao is one of the most successful and revolutionary startups in
Uniswap is another Ethereum based protocol that allows the exchange of ERC 20 tokens without the need of a middleman. It is the most popular DAPP (Decentralised application) on Ethereum.
Compound is another famous App on the Ethereum blockchain. Compound allows people to earn interest or borrow cryptographic assets easily without any negotiation with the counterparty.
4. SUMMARY :
Decentralized finance has brought a revolutionary wave in the financial system by decentralizing the existing centralized financial system. It has led to transparency and immutability of transactions.
With the help of DeFi, a user doesn’t have to worry about getting into banking frauds and can safely process transactions. And most importantly, “ DeFi is open for all”. Anyone regardless of their background or documents can easily use DeFi as per their need.