DeFi – Decentralized Finance or Open Finance is probably a term that you have seen quite a lot lately. Yes, it can be said that DeFi is the current "trend".
So what is DeFi? Whether this trend will "soon bloom and die" or will usher in a "new revolution",… All will be in the next blog post. Let's find out together!
What is DeFi?
DeFi is an acronym for Decentralized Finance (decentralized / open finance). This is a term used to refer to financial applications built on Blockchain.
More specifically, DeFi is the "path" to bring traditional financial products to the decentralized "land". There, the need for third parties is eliminated (or minimized), transparency and safety are enhanced, and costs are reduced.
Currently, Ethereum is the platform with the most active DeFi applications. However, this is not the only Blockchain chosen by applications; Besides, there are also Blockchain of IOST, EOS, TRON.
The purpose of DeFi
In traditional finance (CeFi – Centralized Finance*), you trust the government to not print money out of the blue so inflation is high; the bank will keep your money safe; and you often profit by entrusting your assets to a third party, which means giving control of your money to someone else.
*CeFi: Traditional Finance/Centralized Finance
But surely you have to agree that even though it is your money, you cannot completely control them 100%, no matter what form above.
DeFi was born with the aim of creating an open financial system for everyone. There, everyone can fully control their assets.
More broadly, DeFi is an ambitious attempt to decentralize core traditional financial use cases, such as trading, lending, investing, wealth management, payments, and insurance. through the use of Blockchain.
So in the future, can DeFi replace CeFi?
Can DeFi Replace CeFi?
Basically, DeFi will not be able to completely replace CeFi. However, they will provide more types of services that CeFi cannot provide.
- Assets will be replaced with cryptocurrency
- Organizations, states, companies will be replaced by Blockchain
- Wherever you are, you only need a device connected to the Internet to access decentralized finance
As such, DeFi tools are certainly different from CeFi tools, even though they offer similar financial services, such as loans.
Not only that, they also provide completely new financial services such as stablecoins (DAI, True USD, ...)
Main features of decentralized finance
DeFi is an open system, so anyone with a device connected to the Internet can easily access it.
Build a main block to make interoperability between blocks simpler. From there, create an ecosystem that is scalable and diversified over time.
In CeFi, providing personal data is one of the indispensable “steps”; However, DeFi is completely different.
DeFi dapps will have limited need for third parties (banks or institutions) for users to truly trust, as they are the custodians of their own assets.
Data on market activities will be displayed on an equal basis to all participants.
Core benefits of decentralized finance
- True Decentralization: Helps Resist Censorship; allow all social classes to participate; and have a trusted third party
- Low Costs, Fast Transactions, and Fraud-Free Contracts: Using Blockchain as Infrastructure
- Users have full control of assets without a third party: Because DeFi allows users to own private keys
- Increased transparency: Thereby reducing risks stemming from personal interests or misinformation
How DeFi Works
Activity on DeFi is not governed by an organization or character, but instead rules are written in code or Smart contract. Once they are deployed on the blockchain, the DeFi dapps will work on their own without any human intervention.
Besides, this smart contract is completely public on the blockchain so anyone can audit it.
In addition, all trading activities are also public. However, due to the privacy impact, identities on transactions will be recorded with a pseudonym by default.
Can decentralized finance be risky?
When it comes to the level of risk, DeFi dapps are currently the "place" most targeted by hackers. Out of all the attacks, the most famous is the DAO that happened in June 6.
In the incident, the hacker transferred a third of the DAO's funds to another account by exploiting a flaw in the encryption. This forced the Ethereum community to hardfork the blockchain to recover the lost funds.
The most recent serious attack is the bZx protocol incident. Hackers attacked twice in a row and stole nearly 2 million USD.
From there, it shows that the technology behind the decentralized financial application is still underdeveloped and has many holes; facilitate attacks, damaging the reputation of the technology.
Some popular DeFi apps
Decentralized lending platform
There are many different financial products based on DeFi. But, the fastest growing and most popular area of DeFi is borrowing and lending platforms.
Similar to a bank, users deposit money and earn interest from those who borrow their money. However, in this case, the bank is no longer an intermediary, but a smart contract that will connect the two users; enforce loan terms and distribute profits.
As you know, the cryptocurrency market is one of the highly volatile markets; Therefore, there is a need for a coin that holds value, and that is stablecoin.
Another popular DeFi application is a decentralized exchange (DEX).
DEXs are cryptocurrency exchanges that use smart contracts to enforce rules, execute trades, and securely handle funds as needed. So when you trade on a DEX, there is no operator, no identity verification or withdrawal fees.
There are also a number of other applications such as decentralized payment platforms (Lightning Network, Helis, xDai,...); Decentralized derivative products (Market protocol, Uma, ...)
Some crypto projects use a decentralized financial system
Why is the application of DeFi still not really popular?
That could be because DeFi has yet to overcome the following major hurdles:
As is known, assets in decentralized finance are in the form of cryptocurrencies. Therefore, the first thing is that cryptocurrency needs to become popular, if you want DeFi, so is it
Currently, liquidity in decentralized finance is still low. Meanwhile, liquidity is a key issue for pricing in the financial industry. As a result, most protocols currently cannot compete with rivals (in CeFi).
Products that are over-collateralized
Since there is currently no credit score or general collateral, many products have to be overcollateralized (sometimes as high as 150%).
This disadvantage reduces leverage for professional traders; or the opportunity to gain access to capital that the user does not own.
This is one of the problems that users are most concerned about. If unfortunately, the smart contract or blockchain layer has an error, it will be difficult to detect because this technology is still too new.
Besides, by design, false or fraudulent transactions will be irreversible on the blockchain.
Although it still faces many problems, the DeFi ecosystem has grown 15 times in the past 2 years.
As of February 2.2020, approximately 3 million ETH has been locked in DeFi applications. In which, lending products are the fastest growing industry.
That shows that decentralized finance really has a lot of potential. And if the disadvantages can be overcome, then DeFi will quickly stand next to CeFi in the future.
Hopefully, through the above article, you have had a clearer view of DeFi. If you have any questions or comments, you can comment below the article.