In the last two decades, the financial industry has significantly evolved. With the inclusion of tech, we have witnessed a great level of innovation and efficiency in the current financial system. The financial sector has been transformed from manual records to digital records and digital ledgers. Payment, lending and borrowing have been transformed with digitisation and transactions are happening on a real-time basis. The banking system has been contributing a significant role in any country’s economy, however there are certain issues which are yet to be resolved. One of such issues is centralization and security.
Banking systems are regulated and centralized. Financial transactions are happening with central decisions. Too much centralization is resulting into frauds and scams. This creates a huge issue for the financial security of the common man who has no option but to follow the rules.
Blockchain technology is a possible solution for the problem of centralization. Blockchain is a secure way to keep a digital decentralized ledger maintained by everyone in the P2P network. Blockchain has gained significant importance in the last couple of years and the finance industry is also getting disrupted due to the use of blockchain technology.
The biggest blockchain use case in the finance industry is Decentralized Finance (DeFi). DeFi is all about managing and monitoring finances in a decentralized way.
What is Decentralized Finance?
Decentralized Finance or DeFi is a concept that uses blockchain or decentralised technology to provide financial solutions like buying, selling, lending, borrowing, and trading in a more efficient and transparent manner.
The key features of DeFi are:
Decentralised- There is no intermediary involved in DeFi transactions; therefore, the transactions with the DeFi application are transparent and seamless. Every process takes place on a DeFi network on a real-time basis and takes just a few fractions of a second.
Trust- As there is no thirds party involved and each party are connected with the other in a network by using cryptography, there is 0% possibility of any fraud or scam. Transaction happens openly and very secure way.
Open and Transparent- All the DeFi applications are open source, meaning the protocols are written, making them completely transparent. All the transactions ledger are made public and distributed.
DeFi comprises various financial solutions such as lending, borrowing, decentralised exchanges, payments etc.
History of DeFi
The history of DeFi starts with the history of blockchain or bitcoin. In January 2009, Satoshi Nakamoto released Bitcoin software – a peer-to-peer digital cash system. Bitcoin gives an intuition of decentralized finance. Bitcoin is the way of sending and receiving money without the need of intermediaries. The journey of bitcoin resulted in new innovations like Ethereum, which is the base for DeFi applications. Most of the DeFi applications are built on Ethereum smart contracts.
Smart Contracts
Smart contracts are digital contracts functioning in the form of self-service applications. Smart contracts are used to execute DeFi transactions. For example, if you request for $1000 from ATM, the ATM will not give $2,000. The ATM will give $2,000 only when you request $2,000 on the ATM. This is how smart contract works, i.e., if all the conditions are met correctly, the transaction will be executed. Smart contracts are immutable, secure and cost-efficient.
It is now possible to introduce various financial services by building applications on the Ethereum platform and implementing transactions through the smart contract. DeFi applications are functioning through decentralised exchanges and lending protocols.
Currently, most of the DeFi applications are built through the Ethereum platform. However, there are many alternative platforms on which DeFi applications can be built, such as - Polygon, Binance smart chain, Solona, Cardano, etc.
Future of DeFi
The financial sector is changing at a swift pace. With the advent of new technologies, the financial sector has been transforming. Blockchain technology can disrupt the current banking system. Decentralization will change the way we deal with money and finances.
In the coming years, we will see more and more startups launching DeFi applications to provide seamless financial services in a decentralised way. With the decentralisation, the future is very innovative and creative. In the journey of decentralisation, there could be many challenges. One of the biggest challenges is to adhere to any country's financial regulations of any country i.e., whether the DeFi applications can continuously operate by meeting the financial rules and regulations. ‘Another music is about to play.
In the 2nd part of this article, I will discuss various DeFi application and their uses.