With the evolution of technology, the world has shifted the trend towards digitalization. Everything now seems to be digitalized including the money and the transactional system.
What does De-Fi mean?
The term De-Fi stands for decentralized finance. It refers to the system of transactions that involves the peer-to-peer transfer of finances without the involvement of a third party. Unlike a traditional market where banks are the central authority
The digital market uses the ethereum trader as an authority and eliminates the participation of any intermediary. The transactions are carried out wholly between the buyer and seller.
An example of De-Fi is the bitcoin software which uses a blockchain network to maintain fund transfer.
How does it work?
Decentralized finance uses technology involving the usage of open-source protocols and a framework of blockchains. It comprises two main components i.e., infrastructure and currency, just like banks and US dollars in a centralized financial system.
A software named Ethereum is used to create smart contracts, which provides automated code for managing the services provided. It contains a set of rules, which once formed cannot be altered. The regulations are fixed by users and are pursued autonomously by Ethereum.
Other than a platform, a reliable currency is also required to build an appropriate decentralized finance system.
The currency should be highly volatile and compatible with the software used as a platform. For example, Bitcoin, a cryptocurrency, is highly compatible with Coinbase and Ethereum.
What are the uses of a De-Fi system?
The progress of cryptocurrencies is highly associated with the evolution of the DeFi system. In the beginning, it was quite difficult to convert cryptocurrency into fiat and fiat into cryptocurrency.
The DeFi system acts as a gateway for the conversion of currencies. It gave birth to stablecoins to provide figures to cryptocurrency.
Lending and Borrowing:
The lending and borrowing in a de-fi system are carried out by smart contracts that contain information about the number of funds.
This is based on stablecoins provided such as DAI through which users can exchange their cryptocurrency and gain profit with the help of it.
Yield farming (YiFi):
YiFi is the term that refers to obtaining maximum yield from cryptocurrency. DeFi platforms provide various ways to attain yield farming by tokenization.
Pros and cons of decentralized finance:
Now, we are going to explain the pros and cons of decentralized finance:
DeFi market provides the following benefits:
It is very easy to access financial transactions regardless of the pressure of any institution. The transactions are carried out peer to peer without the involvement of a third party.
The blockchain network is composed of a framework of blocks, each block contains confidential information. The set of terms and conditions, once approved, are not alterable hence increasing the immutability. This is how the DeFi system is beneficial.
The decentralized finance system enables users to see transactions from all over the world. It means all the transactions and data are open to everyone in the industry. This makes the system more transparent.
4. Direct lending and borrowing
Centralized finance requires banks for verification of lending and borrowing. It may incur some charges as well. Whereas in the DeFi system, no charges are applied and it’s cashless. Hence time is also saved.
On one hand, the DeFi system is advantageous in many aspects but on the other hand, it has certain serious disadvantages too. They are listed below:
Scalability refers to the increase of business by adding more sources to it. Every transaction is made public and registered on a blockchain network using cryptographic technology. This limits the number of transactions at a single time.
The factor of uncertainty greatly affects the DeFi system. In some cases, the input malfunctions, or the market value of its currency may fall in an instance. This makes it riskier to invest in decentralized finance.
Liquidity is also a matter of concern in a DeFi system. Sometimes the digital assets are not exchanged as money. It is another disadvantage of the DeFi system. Hence, you cannot place your complete trust in the DeFi market.
Wrapping it up
The discussion leads to infer that the DeFi market is developing as the cryptocurrency is growing. This can be beneficial for business investors because of its benefits.