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Decentralised Finance (DeFi) is a new financial system or a movement that enables users to access borrowing, lending, and trading services without relying on traditional central authorities.DeFi operates through Decentralised Applications (dApps) which are mostly hosted on the Ethereum platform.
DeFi is not a single product or company, but rather a collection of financial services that mimic traditional financial industries such as banking, insurance, bonds, money markets, and others.
DeFi dApps allow users to combine these services to achieve their financial objectives. Because of its modularity, it is frequently referred to as money LEGOs💲
Why DeFi ?
Let’s first understand how traditional finance works🤑
Banks are a vital part of the moving machine that is the financial industry. They facilitate the movement of money around the world by offering value transfer services (deposit, withdrawal, transfers), extending credit lines (loans), and other services.
Banks, on the other hand, are managed by humans and governed by policies that are vulnerable to human-related risks like mismanagement and corruption🤲
The 2008 financial crisis was one of the most severe economic downturns in modern history.The crisis exposed the traditional financial system’s flaws and highlighted the need for it to improve🥲
DeFi aims to create a better financial landscape enabled by the internet and blockchain technology, focusing on three key segments of the banking system:
1. Payment and Clearance System
Sending money to another country through banks is often a slow and costly process, with remittances taking several working days to complete and involving various fees.
Cryptocurrencies used in the DeFi movement enable people to avoid intermediaries that charge high transfer fees. The process is also faster, and transfers can be completed with relatively lower fees compared to banks. Transfers of cryptocurrencies to any account globally take between 15 seconds to 5 minutes, with a small fee involved.
2. Accessibility
As of 2017, 1.7 billion people lack access to bank accounts, but two-thirds of them have mobile phones. DeFi offers an accessible gateway for the unbanked to access financial products and transactions without traditional banks’ lengthy verification processes. DeFi aims to provide financial products for everyone, regardless of discrimination.
3. Centralisation & Transparency
Traditional banks can fail and are centralized points of failure in the financial system. They lack transparency, as evidenced by credit rating agencies’ high ratings for risky securities leading up to the 2008 financial crisis.
DeFi protocols are transparent and auditable because they are built on public blockchains like Ethereum and are mostly open-source. Decentralized governing organizations ensure that all participants are treated equally, and there is no single bad actor. The protocols are written as lines of code and cannot be cheated, and any flaws become apparent through public scrutiny.
Cons
DeFi is a rapidly growing field that offers many advantages over traditional finance. However, there are also some disadvantages to DeFi, including:
- High Volatility📈: The value of cryptocurrencies, which are often used in DeFi, can be highly volatile. This means that investments in DeFi can be risky and may result in significant losses
- Lack of Regulation👁️: DeFi is largely unregulated, which can make it difficult for investors to protect their investments and ensure that they are not being taken advantage of by bad actors.
- Smart Contract Risks🤖: DeFi is based on the use of smart contracts, which are self-executing programs that are not easily modified once they are deployed. If there are errors in the smart contract code, it can result in significant financial losses for users.
- Limited Adoption🥸: DeFi is still in its early stages of development, and many people are not yet familiar with how it works. As a result, there is limited adoption, which can make it difficult for users to find the liquidity they need.
- User Error Risk❌: The decentralised nature of DeFi means that users are responsible for managing their own funds and transactions. This can be risky for users who are not familiar with how DeFi works, as they may make mistakes that result in the loss of their funds.
Further Reading :
- The 7 Major Flaws of the Global Financial System
- Decentralised Finance vs Traditional Finance: What You Need To Know
- How Decentralised Finance Could Make Investing More Accessible
I hope this post has been informative and helpful in understanding the advantages and disadvantages of DeFi. Thanks for taking the time to read this post. If you found it useful, please share it with your friends and colleagues 🥳
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