The effects of decentralized finance (DeFi) on conventional banking

What is DeFi?

Currently, banks manage exchanges and serve as money depositories. Therefore, all banking services—including credit, loans, and insurance—are centralized. Partners and intermediaries must be paid, and in order to use their services, you must be qualified and have the time.

Decentralized finance gets rid of middlemen and, based on the product, provides a higher rate of return. DeFI's guiding philosophy is to make the financial system directly accessible to everyone. There is no longer a requirement for an account, and access requirements are much more flexible.

Decentralized finance is therefore a new type of financial system. Although it's challenging to provide a precise description, we can sum up decentralized finance in three main ways:

Decentralized financial products and services allow anyone to save, exchange financial assets, lend, and borrow money. Decentralized finance is based on secure, public, open-source technologies called blockchains. It is an alternative to the established financial system that is modern, global, and accessible to all thanks to the Internet.

Why Blockchain in Transactions?

Why is this new method of conducting transactions attracting more and more users? The key justification is that it provides a respectable substitute for the financial industry's monopoly. DeFi opens the door to a system that is more open, quicker, less expensive, and operates independently of a centralized authority.

A blockchain by its very nature gives some transparency and makes a lot of information openly available. Customers can emancipate themselves from the current system, which they have little control over, as a result.

By providing both conventional and more innovative services and opening the doors to the financial world in an unprecedented way, DeFi provides a compelling potential in comparison to traditional banks.

How was the concept for "DeFi" created?

The invention of this decentralized financial system is only formally attributed to some. However, we can identify a few key innovations that contributed to its construction. One of these was the creation of Bitcoin in 2008, followed by Ethereum in 2014.

In addition to being a cryptocurrency, Bitcoin also functions as a payment system, which is the first instance of decentralized banking. Owning, managing, and transferring money is now possible from anywhere in the globe thanks to Bitcoin. Since there is no middleman to handle transactions, nobody needs to trust a bank or a payment application. Everything is handled by algorithms, computer programs, and cryptographic calculations.

It is open to everyone and the rules cannot, in theory, be altered. Regarding Ethereum, it was created using a concept similar to that of Bitcoin but with extra features. More advanced than Bitcoin is Ethereum. Its programming capabilities, which employ so-called "smart contracts," enable a variety of financial processes comparable to those found in traditional finance.

What advantages does decentralized finance offer?

The majority of the current financial services have an alternative to decentralized finance. Every day, the developers creating applications for the Ethereum blockchain test out fresh ideas for enhancing existing protocols and even creating brand-new financial systems. The process is still in its infancy. The following are only a handful of the crucial financial services offered by DeFi:

1. Send money anytime, anyplace

Ethereum enables quick money transfers between several cryptocurrency wallets. Simply by entering the target wallet's address, you can send anything from €10 to €150,000 in a couple of seconds. It is just as simple to send an email.

2. Employ reliable cryptocurrency

The value of cryptocurrencies might change significantly at times. For instance, it's challenging to request a salary in ether. Stablecoins were developed to address this volatility issue for this reason.

"Stablecoin" refers to a stablecoin. The value of a financial asset like the dollar or the euro is associated with that of this asset. For instance, a US Dollar coin always costs about $1. It may occasionally change to $0.99 or $1.01.

True decentralization is not achieved by the USD Coin (USDC). In actuality, Circle and Coinbase collaborated to design it. It must be ensured that a stablecoin's value actually exists somewhere (in a safe, for example) in order for it to have real value. A team of auditors and financial professionals from the auditing company Grant Thornton LLP provide monthly attestations on the US dollar reserves supporting the price of USDC in circulation.

3. Taking a loan

Financial decentralization is transforming how we borrow. The borrower must put down collateral before borrowing, therefore neither the lender nor the borrower need to know one another in order to trust one another. The counterparty automatically pays the loan back to recoup its capital in the event of default. This makes borrowing possible:

without a health check, without being prevented by a "too high" debt ratio, and anonymously.

4. Save

You can get interest on the money you put to work for you in a number of ways. Similar to a savings account, but with larger returns on investment (in%) than conventional, regulated financial products. A 4% annual return is typical, if not low, in the crypto world.

5. Trading

For traders, there are more sophisticated choices. There are several options, including limit orders and leveraged trading. The international crypto market benefits from decentralized trading because it never closes and you may maintain complete control over your assets.

6. Funding the launch of a business

Decentralized finance provides a remedy for the start-up founders' lack of cash flow. The process of raising money is made simpler because any professional may now develop their own token to divide up their company into shares and make their cash available to be sold to investors.

The Security Token Offering (STO), a crucial mechanism to be aware of, has made it possible to finance projects through tokenizing assets, which was born with the Ethereum blockchain.

An STO entails the issuance of crypto tokens, which serve as a digital representation of the financial assets of a corporation. They can be swiftly and readily exchanged by holders, much like shares. This makes issuing securities to fund your business initiative simple. These securities are highly transferrable, regulated, and secure.

What advantages does decentralized finance offer?

How does DeFi function?

To put it as simply as possible, we may state that DeFi makes it feasible to use cryptocurrencies and smart contracts to access financial services without middlemen centralizing business processes.

Presently, financial institutions oversee, monitor, and approve almost all transactions involving the exchange of money. Since private middlemen have a vested interest in keeping everyone in the dark about what happens to our money once it is in "our" bank account, to which they have access, we have given them unheard-of authority for generations.

The only intermediates in DeFi that perform the specified activities are smart contracts. You may say that they serve in a capacity similar to that of a bank, insurer, broker, or credit institution. The status and specific terms of these contracts are open to anyone's review. Once the smart contract is live, nobody can change it.

The crucial role played by Ethereum

The creation of the Ethereum blockchain by Vitalik Buterin between 2013 and 2015 is one of the most significant advancements in the cryptocurrency industry.

Today, it has its own programming language, Solidity, and token, the ether. This language allows smart contracts to automatically carry out desired actions after gathering the appropriate information.

Nobody is in charge of Ethereum. Even investors with large ether holdings are unable to alter the rules to their benefit. A shared, international public ledger is akin to the Ethereum blockchain. Each "account" and each transaction are open to the public.

Ethereum technology is used for communication between DeFi products and services. They coexist harmoniously. On one platform, you can lend tokens, and on a different application, you can redeem the token that serves as the loan guarantee.

It's comparable to using gas card rewards points to pay a mortgage installment payment.

What opportunities exist for the banking industry, then?

It is not necessary for banks to outright reject decentralized financing or to make it their primary business. Investing in this emerging market is one option, as an example. The age of cryptocurrencies may come faster than we anticipate if we consider CBDCs (central bank digital currency)!

Customers are already searching for a more adaptable, advantageous, and unrestricted system, as seen by the popularity of DeFi, whose total locked value (TVL) surged 88-fold in a single year. It's bringing about transformation in the sector and indicating new directions for finance.

In conclusion, areas that need further attention are the development of decentralized finance (DeFi) and how it affects the conventional banking industry. DeFi offers a respectable alternative to the centralized banking paradigm that has been the norm for decades, representing a dramatic transformation in the way financial services are provided and used.

DeFi is distinguished by a number of significant characteristics, including its inventiveness, worldwide reach, and Internet accessibility. All financial services, including savings, asset exchanges, loans, and borrowing, are made available to everyone with quicker access and more lenient admission requirements. Blockchain technology, which is transparent and safe, enables all of this.

One of the key factors contributing to DeFi's success is the transparency that blockchain technology inherently offers. By removing themselves from the control of conventional financial institutions, users can have more control over their transactions and assets. DeFi opens the door to a financial system that is more open, quicker, more efficient and operates without a central authority.

DeFi can be partly credited to significant inventions like Bitcoin, which popularized the idea of cryptocurrencies and transactions without middlemen, and Ethereum, which expanded these notions by incorporating smart contracts. These developments have made it possible for a thriving DeFi ecosystem.

DeFi provides a wide range of financial services, including quick money transfers, the use of stablecoins to reduce cryptocurrency volatility, and borrowing without the need for credit checks or high debt loads. Additionally, it provides cutting-edge trading alternatives, savings opportunities with better returns than traditional financial products, and creative ways to finance start-ups through asset tokenization.

DeFi is ultimately changing the financial environment by doing away with many conventional middlemen, fostering accessibility and openness, and encouraging innovation. Traditional banks need to change in order to stay relevant, but they are not necessarily doomed. The shift to a more digital financial environment may require the use of central bank digital currencies (CBDCs).

DeFi pledges to keep developing, presenting fresh chances and difficulties. Consumers, financial institutions, and regulators must be prepared to adjust to these changes and capitalize on the promise of this burgeoning financial revolution. In the end, DeFi provides a sneak preview of the fascinating possibilities looming over the financial industry.

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