While the concept of decentralized finance isn’t new, the technology enabling its implementation is revolutionary — blockchain has enabled a transparent, secure, and efficient way to manage financial transactions without the need for traditional intermediaries. Every technology has a fundamental building block; for Decentralized Finance (DeFi), it is blockchain. The introduction of blockchain technology has brought a new order of financial assets, with DeFi being one of the most mind-blowing — but what does the future hold?
Decentralized Finance
DeFi is a financial technology based on distributed ledger technology (DLT), such as blockchain, which removes the need for third parties and centralized control in transactions.
Blockchain technology allows the democratization of data, so each connected node (computer) has the same data stored and prevents one user from making changes. Blockchain enables all DeFi applications, such as yield farming, borrowing lending, decentralized trading, tokenization, permissionless transactions, self-custody, and transparency.
DeFi relies on peer-to-peer financial networks, computer programs, and security protocols to achieve independence from third-party intermediaries, such as government agencies, banks, and fintech services companies. It expands the possibilities of finance beyond the reach of fiat assets, using immutable smart contracts open to anyone with an internet connection and an eye for investments.
Here are some of the top applications of DeFi:
Decentralized Loans
The concept of loans in DeFi takes an exciting turn where lenders and borrowers are directly connected and agree on terms without intermediaries like banks or credit unions. Decentralized borrowing involves lenders depositing their cryptocurrencies (also known as crypto) on the platform and borrowers taking loans at the specified interest. Borrowers often pledge another cryptocurrency as collateral while taking DeFi loans, while the lenders earn interest on the loans. Blockchain enables this by providing the underlying technology for smart contracts, which crypto lending platforms use to match lenders with borrowers and calculate the interest rate.
Yield Farming
Yield farming allows crypto owners to save money and earn profits. It involves crypto owners staking their assets to earn rewards, typically other cryptocurrencies. The uniqueness of yield farming is that stakers can move their tokens from one liquidity pool to another, allowing them to maximize returns from different interest rates. The liquidity protocol uses the deposited tokens for various purposes, usually to provide proof-of-stake funds for mining new tokens on a blockchain. Crypto users can lock up funds for yield farming using two methods: fixed and flexible locks. In the former, the tokens are locked until a fixed time, while the latter allows the owners to unlock and use their tokens at any time.
Providing Liquidity
Liquidity is important in all financial markets as it impacts the ease of trading assets and their prices. In the crypto market, crypto owners can add funds to liquidity pools, which are then used to facilitate easy trading on exchanges. The crypto owners receive a portion of the fees generated from such trades as their reward for providing liquidity. Blockchain enables this process, enhancing the liquidity processes of traditional finance, which relies on developing marketplaces for trading. Blockchain-based DeFi protocols allow liquidity providers to quickly switch from one protocol to another without affecting the crypto market.
Payments
Payment facilitation is one of the primary services that financial institutions offer. Cryptocurrencies are increasingly used for local and international payments, especially through stablecoins pegged to fiat currencies. Blockchain-based payment gateways are now popular for companies and sellers to receive money, while crypto owners explore peer-to-peer networks for sending and receiving funds. Crypto payments have the advantage of privacy, speed, low fees, and cross-border payment, allowing anyone with an internet connection to send and receive funds without intermediaries.
Gaming, Tokenization, and Non-Fungible Tokens (NFTs)
Decentralized finance is also driving the way gamers incorporate finance into entertainment. Gamification allows gamers to buy and earn in-game tokens to exchange for cryptocurrencies. The blockchain-based gaming industry will reach US$614.91 million by 2030 at a compound annual growth rate (CAGR) of 21.8%. DeFi also allows tokenizing real-world projects across many sectors, like real estate, commodities, social clubs, etc. Tokenization brings the best of real-world projects and digital assets to create new opportunities for partakers. NFTs are also popular today thanks to smart contracts. They allow creators to store their intellectual properties on blockchains safely.
How DeFi Is Disrupting Traditional Financial Systems
Adopting blockchain technology has several challenges, but the current realities and potentials suggest blockchain will disrupt traditional financial systems in diverse ways. This is due to the five key advantages of blockchain-based solutions, such as DeFi systems, over traditional tools.
- Low fees: DeFi platforms typically charge lower transaction fees. For instance, crypto owners can transfer millions in USDT or BTC (Bitcoin) while paying less than $2, whereas similar transactions could cost more.
- Autonomy: Crypto owners retain control over their assets at all times.
- Accessibility: Internet access is the basic requirement to explore blockchain-based solutions. There are no true geographical or political limits.
- Higher interest rates: DeFi protocols typically offer higher interest rates than banks and other institutions that lend money.
- Transparency and security: Blockchain transactions are irreversible, anonymous, and secured using various protocols.
The Role of Crypto Trading Platforms in Traditional-DeFi Transformation
Traditionally, trading platforms have been known to offer traders a way to earn money by speculating on major financial assets like currencies (forex trading), stocks, commodities, etc. The introduction of crypto trading platforms further propelled the adoption of cryptocurrencies as a currency and financial asset. Crypto trading platforms provide access so traders can buy and sell cryptocurrencies directly or trade contracts on underlying tokens. A crypto trading platform ensures traders comply with local regulations and enjoy the safety of structured systems while making money from trading cryptocurrencies.
A Simple Catalyst for Financial Revolution
Blockchain drives DeFi and will be vital in expanding the possibilities of the new peer-to-peer financial system. With the global adoption of cryptocurrencies reaching new levels, we can expect the crypto market to become more valuable and attract new projects with real-world applications in the coming ye