Decentralized finance (DeFi) is a new financial system based on distributed ledgers that are similar to those used in common cryptocurrencies. The system decentralizes power over money, mutual funds, and financial services from banks and other financial institutions.
DeFi vs. Centralized Finance
To grasp decentralized finance properly, you must first understand centralized finance systems and how they differ from each other.
Centralized Finance
A centralized market is a financial market system in which all orders are processed through a centrally located exchange, and no other market exists. A centralized market ensures that deals are fair, that more business is done, and that the buying and selling process is quickened.
Money is held in centralized banks by companies whose ultimate objective is to make money through a centralized finance system. Third parties who assist the flow of funds between clients flourish in the financial system, each charging a charge for their services.
Decentralized Finance
By allowing individuals and organizations to perform financial transactions using modern technologies and internet access, decentralized finance eliminates middlemen. There is no central authority that may reject payments or refuse you access to something. Services that were once slow and susceptible to errors are now automatic and safer, due to writing code that anybody can examine and evaluate.
Why is DeFi Relevant?
Some DeFi experts believe that there may be a fundamental change in how people engage with finance and that it will open up the world of finance to everyone who wants to participate.
However, critics argue that the industry is dangerous and vulnerable to fraud due to a lack of regulation. In 2021, hackers stole more than $10 billion via DeFi apps. DeFi apps are also becoming a more common tool for laundering money.
Many refer to DeFi as a “fool’s gold rush” by the Acting US comptroller of the currency, Michael Hsu.
Benefits of DeFi
A few benefits of using DeFi are: DeFi does not require personal data from its users; getting access to it is simple; all you need to do is create a virtual wallet. You may shift your possessions anywhere you want, whenever you want, without having to get approval, wait for long transactions to complete, or pay ridiculous costs. Also, the whole set of transactions is visible to everyone engaged.
Downsides of DeFi
For tax purposes, you must keep your own records, and regulations differ from one jurisdiction to the next. Your investment may see considerable instability depending on which dApps you use and how you use them, and active trading on the Ethereum blockchain might become costly due to varying transaction rates.
Takeaways
- Decentralized finance (DeFi) is a new financial system based on distributed ledgers that are similar to those used in common cryptocurrencies.
- By allowing individuals to perform financial transactions using modern technologies, decentralized finance eliminates middlemen.
- DeFi experts believe that there may be a fundamental change in how people engage with finance.
- DeFi requires no personal data from its users, getting access to it easy; all you need to do is create a digital wallet.
- Critics argue that DeFi is dangerous and vulnerable to fraud due to a lack of regulation.
