DeFi is a movement that’s taken the financial world by storm. Following centuries of banks and governments controlling the distribution, creation, and holding of our finances, many people have started looking for alternatives.
Now, thanks to modern technologies, those alternatives now exist.
What is DeFi?
DeFi, or Decentralised Finance, is a peer-to-peer financial system based on the blockchain. It’s a move away from traditional banking methods, where you’re trusting a financial institution to hold your money securely, and towards a system where there’s no trust needed.
Just like with traditional banking, you can borrow, lend, trade, and invest with DeFi. However, thanks to its peer-to-peer nature, there are several benefits of doing this through DeFi as well as entirely new financial products and yield generating opportunities.
Why is DeFi becoming more popular?
The 2008 financial crisis demonstrated the issues with a centralised too big to fail institutions. Further, unprecedented stimulus from Central Banks has undoubtably contributed to high inflation. All of this has led to many people questioning whether banks, and by extension governments, really knew what was best for their finances.
More alarming has been instances where banks have taken money out of their customers accounts to bail themselves out (such as in Cyprus in 2013). Unsurprisingly, people have begun to resent paying the price for multiple mistakes made by the banks themselves. Naturally, many people have begun looking for an alternative way to look after their finances – enter DeFi.
What are DEXs?
Decentralised Exchanges, or DEXs, are similar to other crypto exchanges such as Binance, except that they require no sign up and no deposit/withdrawal of assets. Instead, two users directly exchange assets or contracts between their wallets. This doesn’t necessarily require any 3rd party input, but some users do still opt to make use of a 3rd party. This is true free market access as anyone with a wallet and internet connection is allowed to participate. This makes it much more inclusive for the poorest in society, who are also the most likely to be unbanked.
Let’s look at the advantages and disadvantages of DeFi.
What are the advantages of DeFi?
DeFi holds several advantages over traditional banking methods, and even over centralised exchanges:
- No intermediaries needed – this can reduce fees
- No deposit of assets – this means that you don’t need to relinquish custody of your assets to a trusted exchange or third party.
- Fast – faster transactions mean that you can transfer or trade assets as you need.
- Accessible – you don’t need permission to apply, meaning that anyone with a wallet and an internet connection can use DeFi applications (dApps).
- Privacy – you don’t need to give any personal details such as name or contact details, something which is valued by many crypto enthusiasts.
- Security – All transactions are on the blockchain ledger, meaning that a network of computers will have a record of transactions. This makes it almost impossible to corrupt the data and steal funds.
What are the disadvantages of DeFi?
While DeFi is very promising, it’s still early days in a lot of ways, and there are some flaws that still need ironing out. And, with just about anything, it’s not perfect.
- Personal responsibility – It’s the users responsibility to avoid mistakes that could lead to loss of funds. There’s no regulator or insurer who can protect you.
- Scams – There are a lot of scams out there, such as pump and dump schemes. As there’s no regulators for DeFi, it’s down to the investor to do their due diligence, and ensure that what they’re buying is a legitimate asset.
- Issues with Smart Contracts – If there’s a slight flaw in the code of a Smart Contract, it could mean a loss of funds.
- Cross blockchain interaction – at the moment, it’s not easy for DeFi ecosystems set up on different blockchains, such as Ethereum and Bitcoin, to interact with each other. Whilst there are projects looking to solve this, a lot of capital is locked out of other chains, reducing liquidity.
DeFi has begun to offer people a way of escaping the old financial system, and has given them complete control over their own finances. While this potentially world changing innovation is still young, there are already some clearly defined advantages offered by it, as well as some possible flaws that will be resolved as the sector matures.
Disclaimer: Nothing within this article should be misconstrued as financial advice. The financial techniques described herein are for educational purposes only. Any financial positions you take on the market are at your own risk and own reward. If you need financial advice or further advice in general, it is recommended that you identify a relevantly qualified individual in your Jurisdiction who can advise you accordingly.