Introduction
Decentralized finance (De-fi) can be described as an open and global financial ecosystem that permits users to engage in financial services without the interference of middlemen. The potential of DEFI depends on regulation and needs of the users. Anyone can use it due to its open-code nature, making it available for adaptation and enhancement to one’s specifications and needs. It is preferred to centralized finance because of its advantageous peer-to-peer digital exchange. The main goal of DEFI is to cut out third-party institutions and the problems that come with them.
How De-fi works
Just like cryptocurrencies, DeFi leverages blockchain’s distributed ledger technology to serve as a globally accessible database for recording financial transactions. Users interact with the DeFi ecosystem through decentralized applications, which utilize self-executing, immutable smart contracts to start or complete transactions. These smart contracts are what make P2P transactions possible without a central governing authority. When a smart contract is initiated, both parties must agree to the same transaction terms upfront, which are then hard-coded into the smart contract. Only when the agreed-upon parameters of the contract are fulfilled is the transaction completed and recorded onto the blockchain. Using key blockchain attributes such as distributed networks and encryption technology, DeFi platforms can offer a secure system to record transactions in a tamper resistant and anonymous manner. This makes the information on the DeFi network impossible to alter, thereby increasing its integrity and reliability.
Block chain
Blockchain is a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a verifiable and permanent way. In blockchain, digital transactions are recorded in blocks and verified through automated processes. If a transaction is verified, the block is closed and encrypted; another block is created with information about the previous block and about newer transactions.
The blocks are "chained" together through the information in each proceeding block, giving it the name blockchain. Information in previous blocks cannot be changed without affecting the following blocks, so there is no way to alter a blockchain. This concept, along with other security protocols, provides the secure nature of a blockchain.
In blockchain, individuals use of e-wallets to interact with the technology. These wallets can send information to a blockchain. Users hold private keys to tokens or cryptocurrencies, which function as passwords. These keys grant them access to virtual tokens that represent value. The ownership of these tokens is transferred by 'sending' an amount to another entity via a wallet. The recipient's wallet then generates a different private key, securing their token ownership. The blockchain's design ensures that this transfer cannot be reversed, adding another layer of security.
Key elements of block chain
*Smart Contracts *
An important term associated with De-Fi is smart contracts. Smart contracts are computer programs stored on blockchain that automatically get executed when the transaction conditions are met; for instance, Dstv subscription and available balance. De-Fi uses smart contracts to create protocols that replicate existing financial services in a more transparent way.
A smart contract is simply an agreement between transaction participants. It is also accessible to public audit. This concept existed long before the creation of cryptocurrency; it was developed by an erudite cryptographer named Szabo Nick in the 1990s. Smart contracts follow the simple if statement blueprint.
*Distributed Ledger Technology *
Distributed ledger technology (DLT) is a digital system for recording the transaction of assets. Transactions and their details are recorded in multiple places simultaneously. Distributed ledgers have no central database or administrative functionality.
All network participants have access to the distributed ledger and its immutable record of transactions. With this shared ledger, transactions are recorded only once, eliminating duplication.
*Immutable Records *
No participant can change or tamper with a transaction after it has been recorded in the shared ledger. If a transaction record includes an error, a new transaction must be added to reverse the mistake.
*Peer to peer *
Blockchains are peer-to-peer (P2P) networks, a decentralized mechanism to conduct transactions between members on the chain without the need for a third-party or central server. This is exactly how cryptocurrency operates. Contrary to the regular client/server model where the client makes a request like executing a transaction, and the server works to fulfill it, on P2P networks each party acts as both – the client and the server. What this technically means is that every member owns a copy of the ledger once the network is formed, which can be used to store and share information without the need for an intermediary.
*Cryptography *
Cryptography is a technique of securing information and communications through the use of codes so that only those persons for whom the information is intended can understand and process it. Thus, preventing unauthorized access to information. The prefix “crypt” means “hidden” and the suffix “graphy” means “writing”.
All transactions and blocks in the blockchain are cryptographically safe and sealed on the network. To maintain security, integrity and validity, the blockchain’s mechanism generates two keys for network members – a public key and a private key. These keys together help unlock a user’s ledger. This technique ensures transactions are impervious to fraud. If two members were to execute a transaction and either one’s private key was compromised, the transaction would not execute.
*Transparency *
Blockchain networks allow transactions recorded on their network to be viewed by any member of the public. Giving members the power to scrutinize records creates transparency and leaves no room for hidden data.
Decentralized applications (De-fi Apps)
A decentralized application, or DApp, is an application that runs on a peer-to-peer network of computers, as opposed to a single computer. The key benefit of this is, users of the network no longer depend on a central computer in-order to send and receive information.
Using cross-border payments as an example, when an individual makes a payment to a person located in another country, a financial institution would help facilitate this payment and in return take a fee for doing so.
However, De-Fi applications can disintermediate the entire process by having an individual send a digital currency from his or her wallet to the intended recipient without the aid of a financial institutions in the middle.
Advantages of De-fi Apps
*High level of security *
This frame work provides a decentralized means of exchange on a P2P network, it encapsulates only active participants of the trade and exempts unnecessary users from the network.
*Open source *
The source code of De-Fi applications is always in free access. Any user can check its reliability, security and functionality.
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Clarity **
Cryptocurrencies are attributed to anonymity because blockchain accounts consist only of numerical addresses. This makes it impossible to tell who they belong to.
*Cross border transaction *
Cross border transaction is one of the advantages of DEFI. It is the ability to transfer funds across different countries in a secure frame work. This is usually favorable to immigrants in western nations that seek financial support from relative or friends but distance being the issue hinders this process.
Autonomy
DeFi platforms don't rely on centralized financial institution. The decentralized nature of DeFi protocols mitigates the costs of administering financial services.
Disadvantage of Dapps
*Regulatory Risk: *
There are no clear regulatory rules in the decentralized space. Anonymity is the order of the day
*Financial risk: *
DEFI’s unique selling point, the absence of intermediaries and ease of access, is also the source of risk. One of the main justifications for how traditional finance restricts access to financial services is to protect users from danger, whether that is explicit from bad actors or implicit from not being equipped to understand the risk. No one is responsible for you. Financial institutions are not responsible for customer actions within the De-Fi system.
Technical risk:
DEFI is programmable finance, so it is only as safe as the code that powers it. Unfortunately, Smart Contracts have proven to present a significant risk to end-users through poorly written codes. The risk of smart contract hacks. A critical bug in the protocols can harm the entire system. In such a situation, hackers can infiltrate any network chain and steal from users.
*Excessive hype and fraud: *
Usually, the introduction of new technology brings about some sort of euphoria, which could be difficult to separate from reality at times.
De-fi Products and service
_Products _
Coins and tokens, such as Ether, Polkadot, Solana, Aave, Synthetix, and Uniswap
Stablecoins, such as DAI, USDC, and USDT
Digital wallets, such as Coinbase and MetaMask
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Services _
DeFi mining, yield farming, and staking, which allow users to earn rewards for providing liquidity or securing the network.
Trading, borrowing, lending, and saving using smart contracts, such as Aave,
Compound, and Maker
Uses of Decentralized app
Some common uses of Decentralized finance:
*Decentralized exchanges: *
The top preference for de-fi app users is accessing decentralized exchanges. Exchanges like Uniswap and PancakeSwap have apps that let you interact with other cryptocurrency users.
Liquidity providers:
Liquidity simply means cash. Provides user with the ability to sell gets assets (stable coins) quickly.
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Lending/Yield Farming: **
There are hundreds of de-fi apps available that provide lending. Generally, they operate the same way as a liquidity pool, where users lock their funds in a pool and let others borrow them, receiving interest on their loans called yield farming. Many provide flash loans, where no collateral is required from the borrower.
Gambling/Prediction Markets:
Millions of dollars in cryptocurrency are used every day for gambling using de-fi apps like ZKasino, Horse Racing Slot Keno Roulett, Azuro, and stake.
*NFTs: *
The market for non-fungible tokens has cooled somewhat, but they are still popular with niche investors and collectors.
Concerns about Defi
Decentralized finance is constantly evolving. It is unregulated, and its ecosystem is vulnerable to faulty programming, hacks, and scams. For example, one of the main ways hackers and thieves steal cryptocurrency is by spotting deficiencies in De-Fi applications. Laws have not yet caught up with advances in technology. Most current laws were crafted based on the idea of separate financial jurisdictions, each with its own set of laws and rules. De-Fi’s borderless transaction presents essential questions for this type of regulation. For example:
Who is responsible for investigating a financial crime that occurs across borders, protocols, and De-Fi apps?
Who would enforce the regulations?
How would they enforce them?
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