In 2020, the total blocked value (TVL) of decentralized finance increased by 2,000 percent. In 2021, decentralized finance is still on the rise. Before investing in this financial ecosystem, read ahead to learn about the pros, cons, and emerging trends.
What is decentralized finance?
Decentralized finance (or DeFi) is a relatively new way to execute financial transactions through apps called DApps. These are built on a blockchain network, most often Ethereum, and do not need to rely on traditional financial intermediaries like banks, brokerages or stock exchanges.
DeFi platforms allow people to lend or borrow money as well as earn interest on savings type accounts. With DeFi, rather than making transactions through a centralized intermediary such as a cryptocurrency exchange or a stock exchange, transactions are made directly between participants using smart contract programs with open software. source designed and maintained by a community of developers.
Emerging trends in decentralized finance
DeFi not only provides a platform for cryptocurrency trading, but also other financial services such as loans and insurance on a decentralized blockchain platform. These services are likely to trigger emerging trends that will impact the financial world. Some notable examples include DeFi insurance, Stablecoin, and decentralized loans.
DeFi Insurance is designed to protect cryptocurrency assets and cover investors from associated risks. In addition, it can help investors protect their DeFi deposits against crypto volatility as well as the risk of theft on crypto wallets and hacks on exchange platforms.
Stablecoins are cryptocurrencies that attach their market value to external benchmarks such as the US dollar or gold.
While cryptocurrencies such as Bitcoin are very volatile and not suitable for daily use by the public, Stablecoin serves as a medium of currency exchange that stores value over a longer period of time. As such, traders and investors are always on the lookout for Stablecoin that stores value and hedges risk.
Crypto Lending is another financial product emerging from the Defi platforms. Crypto holders can lend on decentralized lending platforms to earn passive income on their holdings through interest charges paid by borrowers. This is a great option for lenders as they can earn relatively low risk interest and the secured borrowing method ensures that lenders will be repaid even if the borrower never repays the loan.
Benefits of decentralized finance
A healthier system
One of the biggest advantages of DeFi is decentralization. The pandemic has shown the world just how vulnerable centralized financial systems are to global uncertainties, as many rely on direct contact between individuals.
On the other hand, with DeFi, the level of physical contact is drastically reduced and such a model has obviously brought success to cryptocurrency prices and businesses.
Fewer human errors
Financial crises are often the result of mismanagement by central banks and intermediaries. This is why DeFi is developed with smart contracts where the protocol advocates transparent execution of contracts without human errors.
Traditional financial transactions can require tedious paperwork or queues at the bank. However, DeFi allows seamless operations anywhere and anytime as long as you have an internet connection.
Disadvantages of decentralized finance
While decentralized lending is an attractive service, it can also suffer from over-collateralization when borrowers’ asset values are much higher relative to the loan amount. This is an essential part of the DeFi protocol as the high collateral can help eliminate issues like credit ratings.
DeFi interacts with a high volume of smart contracts and decentralized blockchain applications to develop new services from existing services. However, since DeFi is an open source system, if the blockchain that hosts a DeFi project is unstable, the project spontaneously inherits this instability from the host.
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Security risks due to administrator keys
When using the DeFi protocol, an administrator key can be used to renew contracts or suspend contracts in an emergency. This key is a double-edged sword; this can act as a precautionary measure but at the same time it could pose a threat if the key lands in the wrong hands.
There are different types of blockchains such as Bitcoin, Ethereum, Binance Smart Chain, etc. Each is a siled ecosystem and DeFi community that do not interact with each other. Poor interoperability limits the development of a unified platform for more flexible transactions.
New paradigm shift in the financial world
If you are considering the crypto market, a little research on decentralized finance can go a long way in helping you understand the evolving ecosystem.