What is DeFi and why is it important?

Over the past few years, we have seen the explosive growth of cryptocurrencies. Most recently, Bitcoin (BTC) bounced back and hit $57,000, blowing a breath of fresh air into the crypto market that had already fallen deeply. Investors started pumping money into the market. However, in this article, Tokenize Xchange would tell you about DeFi, an important aspect in the cryptocurrency world. So what is DeFi? And what application do cryptocurrencies have in DeFi? 

What is DeFi?

DeFi (Decentralized Finance) is a system of financial products developed on a decentralized blockchain. Compared with traditional financial products like banks, DeFi has some clear advantages. For example, a customer needs to own an identity card issued by an authorized organization to use banking services while DeFi is exactly the opposite. Buyers, sellers, lenders, or borrowers can all interact peer-to-peer without having to go through a third intermediary. 

These interactions are based on certain software, so it would be controlled much more tightly when compared to a company or organization that supports the transaction. Most current DeFi applications run on Ethereum – ERC20.

DeFi vs traditional financial products

The biggest advantage of DeFi is its ability to solve problems that exist in the traditional financial system:

• Some individuals are not authorized to set up accounts or use financial services.
• Lack of access to financial services.
• Financial services have the ability to block your payment functionality.
• Risk of loss of personal information.
• Governments or centralized organizations can shut down services 
• Transactions are usually made during specific hours.
• Transfers can take a long time due to manual processing.

Despite having many advantages over traditional finance, DeFi still has certain disadvantages:

Technological risks: DeFi is operated on a system of smart contracts and tokens on the blockchain. So if something goes wrong with the developer’s script, the apps can have problems. That is also the weakness of DeFi’s protocol.

Asset Risk: When borrowing money on the app, users must provide other cryptocurrencies as collateral. Since cryptocurrencies are subject to frequent price fluctuations, when the market is going down, those collaterals are likely to drop in value significantly, at risk of being liquidated.

Financial product risk: Even if the loan is collateralized with a certain amount of cryptocurrency, the borrower using the DeFi protocol is still not responsible if the loan interest is not effectively paid. fruit. This is the reason that financial experts often recommend that you only invest the money you can spend and research carefully before investing.

How DeFi Works and the Role of Cryptocurrency

The DeFi system achieves distributed consensus using smart contracts on blockchains like Ethereum. Developers write smart contracts to perform specific actions when certain conditions are met.

When a smart contract is developed on the blockchain, everyone can access and monitor it, but no one has the right to change it. These smart contracts often govern decentralized applications, not owned or controlled by any organization or individual.

Some popular DeFi applications include:

Stablecoins: As a cryptocurrency with a stable value, stablecoins have a value that is less volatile than other cryptocurrencies on the market and is often used to conduct normal transactions. Currently, there are many popular stablecoins such as USDT, USDC, DAI, .. with the value of these coins being almost equivalent to 1 USD.

Decentralized Exchange: Despite its decentralized nature, some cryptocurrency exchanges like Tokenize Xchange act as a centralized exchange to connect buyers and sellers. Using a decentralized exchange allows users to hold full control of their cryptocurrencies instead of depositing them in an account managed by a centralized exchange, which can be targeted by hackers. 

Borrowing and lending: This is perhaps the most traditional function of DeFi. Those who own a substantial amount of cryptocurrency but want liquidity in another cryptocurrency can borrow money using crypto as collateral. Dapps are designed to facilitate decentralized lending and borrowing. Dapps can also automatically adjust interest rates based on changes in the supply and demand of cryptocurrencies.

And some other applications such as insurance, savings, financial management, etc.

Why DeFi is important in worldwide finance?

In addition to being able to solve the limitations of traditional finance as described above, DeFi can bring users several key benefits as follows:

Accessibility: Some individuals may not be able to open a bank account or get a loan from a traditional financial institution, but anyone with an internet connection can access a DeFi platform. Also, DeFi transactions can take place globally without geographical barriers.

Transparency and security: Smart contracts and transaction history cannot be changed and are published on the blockchain for anyone to see. 

Autonomy: DeFi platforms are not managed by any centralized financial institution. As for traditional finance, these institutions typically hold your money with the risk of overuse or bankruptcy. The 2008 financial crash, for example, showed the weakness of the centralized financial system.