Is a bank less transaction possible? Is it possible to trade, deposit or invest without intermediary fees? Is it possible to build a secured transaction system with enough transparency for the customers?
The proverb says everything is possible, but it feels great to experience the enormous vastness of possibilities. Decentralized Finance is like the same thing, a revolutionary financial system with features banks was unable to provide.
Although we are fully thankful for the traditional baking system, they’ve provided wealth management services since the medieval era.
Today’s advanced generation requires next-level banking and transaction features which DeFi claims to possess. So, let’s condense our thoughts around DeFi development. We’ll discuss how the DeFi system is capable of developing a better alternative financial ecosystem, with challenges and future possibilities it brings alongside.
A Brief on DeFi
DeFi, alias Decentralized Finance, is the decentralized alternative to the traditional financial system. It sounds confusing, but DeFi system usability is easier than TradFi. The simple explanation of DeFi would be a self-custody finance system. Instead of banks and financial institutions, Individual people hold their wealth in a predefined systematic environment.
Using the DeFi financial ecosystem, individuals can invest, trade, and buy various tangible or intangible assets. Likewise, DeFi also helps facilitate peer-to-peer mortgaging and money lending, with transaction time less than traditional finance systems.
Here Comes Blockchain
A blockchain system is a shared, decentralized ledger with data immutability features, which helps track and record transactions and assets within a business or mutual network. Unlike traditional ledgers, blockchain provides full data transparency among its participants.
Blockchain uses peer-to-peer technology to store financial transactions. In a peer-to-peer system, every participant residing is simultaneously a data keeper and accessor. Central authority occurrence isn’t possible in peer-to-peer networks; every participant exchanges data and information within them.
How Smart Contracts Interconnects Blockchain and DeFi
Smart Contracts are nothing but automated programming, which is liable to manage and organize a DeFi. In a simple manner, Smart Contracts are digital versions of physical agreements mandatory for any DeFi project. In a business or recurring financial transaction, Smart Contracts become the middleman and bring efficiency and simplicity to the ecosystem.
Using programming languages, developers establish a consensus within a DeFi consisting of predefined working responsibilities. These Smart Contracts are capable of automating financial activities like user verification, lending management, insurance claim automation, trade settlement and more. Another advancement of Smart Contracts is facilitating DeFi-based Cross-Border payments with fewer transaction days, a minimum transaction, and much more transparency.
All the transactions happening through DeFi systems automatically store in a blockchain network. Participants can always access financial information without data manipulation, data silos or security breach probabilities.
3 Use-Cases Of DeFi
Automated claim settlement with faster rate, claim verification and less human involvement, the DeFi insurance ecosystem is much lighter, cost-effective and faster than traditional insurance systems.
DeFi uses Smart Contracts to manage every insurance operation. As Smart Contracts are predefined and self-executing, human intervention will be a once-in-a-long-time thing for maintenance purposes. Thus, insurance organizations can save thousands of bucks throughout their daily operations.
Smart Contracts are faster than humans, so conducting claim settlement is much easier. Likewise, Smart Contracts with Artificial Intelligence and IoT infusion can help in claim verification.
Decentralized systems facilitate everything through digital mediums, so paperwork and filing procession aren’t going to waste time. Automatically, DeFi insurance is a much healthier option than traditional insurance.
2. Asset Management
DeFi expands users’ control over their wealth and assets. With expanded control, users can take financial decisions fluidly towards building wealth or earning through assets.
The DeFi ecosystem comes with better trading, investing and wealth management tools. Through these tools, users get a fair idea of independence upon their wealth, as well as managing and organizing assets becomes easier than traditional Finance.
Providing greater privacy and security over asset management is also DeFi’s benefit. DeFi avails users with great password encryption, private key protection and advanced security tools, with blockchain’s efficiency. Being a self-custodian is easy in the DeFi system.
3. DeFi Exchanges
DeFi introduced simplicity, low transaction fees and reduced settlement days, which traditional Finance lacked. With blockchain-provided security standards, users can easily avoid market manipulation and theft probabilities. Likewise, users can achieve more efficiency and control over their wealth.
Challenges In DeFi
1. High levels of Energy Requirement
Statistics suggest that one Ethereum transaction takes up energy capable of converting 100000 VISA transactions. With this scenario, it seems challenging for DeFi to keep thriving in the future. Similarly, global energy usage is predicting a major 48% growth, so DeFi systems must be aligned with this increased energy curve.
Technological development can lower energy usage by converting DeFi transactions. Proof-of-stake uses less power, and another technical advancement is proof. A sign of hope.
2. Totally Unregulated Environment
Decentralization protocols are composed around building a financial environment without centralized control. The benefits of such a network are reduced intermediates, lower transactions etc. However, like a coin has two sides, the traditional financial ecosystem has its cons, which is less guidance.
Financial regulations related to investment and taxation require necessary monitoring and tracking, and an unregulated environment lacks these guiding protocols. Without guiding protocols, financial activities can hamper economic infrastructure.
CeDeFi is an evolved version of DeFi and traditional Finance, which is developed taking the goods of both sides. The challenge related to regulatory Finance can be modified through CeDeFi.
3. High-volatility Dependence
Another challenge with DeFi is cryptocurrency dependency. Unlike fiat currencies, cryptos are highly-volatile, so factors like gas fees, transaction fees and exchange rates behave the same. Likewise, cryptos are highly speculation sensitive, which shows a high chance of payment inefficiency through exchanging money.
DeFi and cryptocurrency still need to be a government-preferred form of Finance, despite numerous next-gen features. Governments are shifting their stance with increasing DeFi usability, yet it has a long journey to destiny.
Ending Thoughts on DeFi’s Future
DeFi is growing exponentially after the cryptocurrency boom. Businesses and startups admiring DeFi technologies will surely take it to the next level.
However, DeFi isn’t fully dependable in today’s circumstances. Factors like energy usage, CO2 emission, and an extremely unregulated environment require further research and development. The market predicts 10% worldwide usage of DeFi by 2030, that’s probably based on the DeFi advancement rate.
Akash Guha is a content writer with a grasp of different web content creation. He has an interest towards writing website content for multiple industries like blockchain, mental health and finance. Also, he is aimed to write simple and easy-to-understand content.