The history of finance is a long and interesting one. You can understand the new idea of adding the term ‘Decentralized’ better by briefly reviewing the mentioned history. In the very beginning, finance had no say in human society. The basic needs were food and shelter and, to some extent, survival. However, as time progressed, the need for interaction among humans became essential; to facilitate this, trade was invented. Trading during this period was basic; you exchanged what you had in abundance for what you needed or were insufficient.
The Downside
However, the problem with this trading method was that there wasn’t a distinguished criterion to determine the value of goods. As the variety of goods continued to expand, the desire for clear criteria also grew, hence the invention of money systems around 600BC. Unfortunately, the narrative doesn’t end with this happy ending. A new problem has emerged, who should control the money systems.
Having money under the control of a single entity. i.e., the government has one major concern, the unrestricted printing of money. The invention of cryptocurrencies such as Bitcoin was the first step to giving people a financial system they could rely on. However, this can still not be seen as decentralized finance, as most crypto financial transactions are carried out through centralized exchanges.
What is DeFi?
DeFi (now version 2.0) is a rapidly growing sector in the crypto industry, and it is composed of many projects on different blockchains. Most of the services from traditional financial systems can be carried out through DeFi without the involvement of third parties such as banks. This is the most prolific feature of DeFi. Most people believe that DeFi is the future of financial systems; these are some of the reasons convincing them:
Error-free
The mismanagement of central banks and third-party intermediaries has caused a major crisis in the current financial system. However, the introduction of smart contracts seeks to eliminate these day-to-day errors.
A Fast And Permanent Access
In the traditional financial system obtaining a loan is a hectic process. You have to be available to fill in several documents at specific times. However, for DeFi, it is quite different. You can easily get a loan from anywhere anytime as long as you are connected to the internet.
Healthier System.
The outbreak of the Coronavirus exposed the vulnerability of our current financial systems. Centralized financial systems depend on contact between individuals. For DeFi, the percentage of contact required for a financial transaction is zero.
Freedom
In traditional financial systems, you must obtain permission from intermediaries to carry out any financial transaction. In DeFi, users can interact with financial services without asking for permission.
However, like any other system, DeFi also has its risks and disadvantages. Here are some of the challenges that face DeFi projects.
- Uncertainty – Suppose the blockchain that parents the DeFi project is not stable; the project also becomes unstable.
- Scalability – Either a transaction process takes too long to be confirmed, or the cost is too high during congestions.
- Issues with smart contracts – If a flaw occurs in contact, however small it might be, funds might be lost.
Other disadvantages of DeFi include low liquidity, over-collateralization, low interoperability, and lack of insurance.
Image Source: Adobe Stock
Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice
