Decentralized finance (DeFi) are decentralized platforms that have financial applications built on public blockchains. They have been created with the purpose of competing against centralized financial institutions like banks.
As we discussed earlier, centralized finance can be traced all the way back to the Bank of England in 1695. Very little effort has been made to modernize the financial services industry. Decentralized finance has the potential to become a major disruptive force in this multi-trillion-dollar industry.
Through its vast array of decentralized networks and open-source software, DeFi is capable of creating multiple types of financial services and products.
Currently, the top 3 categories of DeFi include;
- Developing monetary banking services.
- Offering peer-to-peer lending and borrowing.
- Enabling tokenization and derivatives.
An example of monetary banking services would involve the issuance of stablecoins. DeFi is also quite prevalent in peer-to-peer lending and borrowing. DeFi platforms connect borrowers and lenders directly, thus removing centralized intermediaries from the equation.
Perhaps the biggest opportunity for DeFi can be found in the tokenization of assets. The list of assets would include such things as stocks, commodities, real estate, precious metals, fine art, and other types of alternative investments. Tokenization would allow assets to be owned and traded on a blockchain using decentralized exchanges. This type of format would provide investors with the opportunity to have complete control of their funds at all times. It would eliminate the need for centralized exchanges and brokerage firms.
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DeFi Benefits the Unbanked
Arguably, the most important benefit of DeFi is the fact that it would allow the unbanked to have access to affordable financial services. The unbanked represents the approximately 1.7 billion people in the world who lack the ability to obtain basic financial services. These services include such things as checking accounts, business loans, personal loans, merchant services, mortgages, retirement planning, and access to capital markets.
As we briefly discussed, the financial services industry has made little effort to change the basic structure of its own industry. This is because there has been no financial incentive to make any radical changes. As you know, the current structure of financial services is centered around the use of intermediaries. The vast majority of financial products require the presence of a middleman between the buyer and seller.
This type of system has been incredibly profitable for financial services companies over the course of the past several decades. A tremendous amount of wealth has been created for individuals and businesses. However, very little of this wealth has been used to build the basic infrastructure needed to provide financial services to the unbanked.
Thanks to decentralized finance, the unbanked actually have an opportunity to receive basic financial services. DeFi is substantially cheaper than traditional financial services because it does not require the use of an intermediary. Consequently, these savings can be passed on to customers.
Despite the huge potential that DeFi brings to the table, a tremendous amount of work lies ahead before decentralized finance becomes a mainstream product. This includes such items as regulatory hurdles, infrastructure, public education, consumer protections, and creating a unified DeFi marketplace. All of these things will take time and a tremendous amount of effort. At least for now, though, it certainly appears as though DeFi is headed in the right direction.
Brief Summary of Decentralized Finance
- DeFi is a decentralized platform with financial applications built on public blockchains.
- DeFi is in direct competition with centralized financial institutions.
- The top 3 categories of DeFi: monetary banking services, P2P lending, and tokenization.
- Tokenization would allow assets to be owned and traded on a decentralized exchange.
- DeFi would eliminate the need for centralized exchanges and brokerage firms.
- DeFi would allow the unbanked to have access to affordable financial services.
- The removal of intermediaries explains why DeFi can afford to service the unbanked.
- Realistically, DeFi is years away from becoming a mainstream product.