DeFi is one of the terms you’d definitely come across if you’re going to be involved in cryptocurrency. DeFi is the abbreviation of Decentralized Finance which uses the same blockchain technology as cryptocurrency.
There’s no way you can talk about decentralized finance if you don’t know centralized finance. DeFi is the latest form of financial technology with the older form being centralized finance.
DeFi has been a useful tool in our world today and has been predicted to have a greater impact in our future as it is growing. Many applications are being launched with DeFi in mind which is already taking over.
In this post, we’ll learn about decentralized finance, how it works, and its use cases. Before then, let’s discuss centralized finance.
What is Centralized Finance?
Centralized finance is the old form of financial technology where your money is by banks, corporations whose overarching goal is to make money.
The financial system is full of third parties who facilitate money movement between parties. In this case, each one charge fees for using their services.
For example, when you buy groceries in a supermarket with your credit card. Your charges is forwarded by the merchant to your bank which forwards the card details to the credit card network. In this case, each entity get some amount for their services.
All other financial transactions cost money. Loan applications can take days to be approved. You may not be able to access the bank or other financial institutions in this case 24/7.
What is DeFi (Decentralized Finance)?
DeFi is the latest form of financial technology which can be termed an upgrade to centralized finance. It is an umbrella term for financial services on public blockchains, primarily Ethereum. It is designed to use cryptocurrency for transactions.
DeFi is therefore based on secure distributed ledgers similar to those used by cryptocurrencies. In contrast to centralized finance, DeFi removes the control banks and institutions have on money, financial products, and financial services.
It removes the third party through peer-to-peer financial networks that use security protocols, connectivity, software, and hardware advancements.
In this system, you can make use of financial services anywhere and anytime as long as you have an internet connection. This is because the technology behind it is a distributed database which is accessible across various locations. It collects and and aggregates data from all users and uses a consensus mechanism for verification.
DeFi applications (dApps)give users more control over their money through personal wallets and trading services that cater to individuals.
How Does It Work?
DeFi works via the use of software called dapps (decentralized applications). This is used to to handle transactions and run the blockchain.
In this way, a blockchain collect information together in groups known as ‘’block’’. They hold set of information when this block reach their storage limits, they are closed and linked to the previously filled block, forming a ‘’Chain’’ of data hence the name ‘blockchain’.
It is important to know that most of the decentralized applications work on the Ethereum blockchain. You don’t have to open an account or fill some applications before using this. It is run smoothly on the blockchain.
How To Make Use of DeFi
Here are some of the ways people are engaging with DeFi today:
1. Getting a loan- As stated earlier, you can make use of services rendered in centralized finance in DeFi. Here, you will make use of dApps to get a loan. An algorithm would match you up with peers that meet your needs. You’d then need to agree to one of the lender’s terms and receive your loan.
2. Lending- With dAPPs, you can not only hold your crypto assets but lend out your crypto and earn interest and rewards every minute. Yes !as a token holder, you make more profits when you are not using your crypto.
3. Trading- Peer-to-peer (P2P) financial transactions are one of the core premises behind DeFi. A P2P DeFi transaction is where two parties agree to exchange cryptocurrency for goods or services with a third party involved. You can therefore peer-to-peer trades of certain crypto assets — as if you could buy and sell stocks without any kind of brokerage.
4. Saving- You can save just as you do in centralized finance using dApps. You can put some of your crypto into savings account alternatives and earn better interest rates. In this system, you can earn more than you do with a conventional bank.
5. Buying derivates- In this system, you can make long or short bets on certain assets. Think of these as the crypto version of stock options or futures contracts.
Is It Safe To Use DeFi?
This is a big question to find ask when using a cryptocurrency/blockchain technology. As it is with every crypto endeavor, DeFi is also risky.
Decentralized finance is still in the beginning stages of its evolution. It is not without infrastructural mishaps, hacks, and scams. DeFi’s borderless transaction ability presents essential questions for this type of regulation.
Asides the security risks, other concerns are system stability, energy requirements, carbon footprint, system upgrades, system maintenance, and hardware failures.
You have to note that fluctuating transaction rates on the Ethereum blockchain means that active trading can get expensive. Your investment could experience high volatility – this is, after all, new tech.
Users need to know that infrastructure for DeFi and its regulation are still under development and debate.
Conclusion
DeFi is an emerging financial technology based on secure distributed ledgers similar to those used by cryptocurrencies. Just as Bitcoins emerged as a solution to financial crisis, DeFi has been tipped as an upgrade to centralized financial system.
With DeFi, you can do most of the things that banks support — earn interest, borrow, lend, buy insurance, trade derivatives, trade assets, and more. It is however, faster and doesn’t require paperwork or a third party.
Despite it features, many questions must be answered and advancements made before DeFi becomes safe to use.
Also Read- Will Cryptocurrency Ever Replace Fiat Currency?
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