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DeFi – Decentralized Finance or Open Finance is probably the term that you have seen quite a lot recently. Yes, it can be said that DeFi is the “trend” nowadays.
So what is DeFi? Whether this trend will “bloom soon” or will open a “new revolution”, … All will be in the following article of CHK. Let’s find out!
What is DeFi?
DeFi stands for Decentralized Finance. This is the term used to refer to the financial applications built on top Blockchain.
More specifically, DeFi is the “way” to bring traditional financial products to a decentralized “land”. There, the need for third parties is eliminated (or minimized), transparency and safety are emphasized, and costs are reduced.
Currently, Ethereum is the platform with the most active DeFi applications. However, this is not the only Blockchain chosen by applications; Besides, there are Blockchain of IOST, EOS, TRON.
The purpose of DeFi
In traditional finance (CeFi – Centralized Finance *), you are confident that the government will not print money all of a sudden to cause inflation to soar; Banks will keep your money safe; and you often make a profit by entrusting your assets to a third party, which means giving control of your money to someone else.
* CeFi: Traditional finance / centralized finance
But you must agree that even if it is your money, you cannot fully control them, regardless of any of the above.
DeFi was born with the aim of creating a financial system open to everyone. There, everyone can completely control their property.
More broadly, DeFi is an ambitious attempt to decentralize core traditional financial use cases, such as transactions, loans, investments, asset management, payments and security. through the use of Blockchain.
So will DeFi be able to replace CeFi in the future?
Can DeFi replace CeFi?
Basically, DeFi will not be able to completely replace CeFi. However, they will provide more types of services that CeFi cannot.
- The property will be replaced with cryptocurrency
- Organizations, states and companies will be replaced by Blockchain
- Wherever you are, as long as you have an Internet-connected device, you can access decentralized finance.
As such, DeFi tools are certainly different from CeFi tools, even though they offer similar financial services, such as loans.
Not only that, they also provide completely new financial services such as stablecoins (DAI, True USD, …).
The main features of decentralized finance
DeFi is an open system, so anyone with a device connected to the Internet can easily access it.
Building a main block makes interoperability between blocks simpler. From there, creating an ecosystem that can expand and become diverse over time.
In CeFi, the provision of personal data is one of the “steps” that cannot be without; However, DeFi is completely different.
DeFi dapps will have a limited need for third parties (banks or institutions) for users to truly trust, since they are the custodians of their own assets.
Data on market performance will be displayed on an equal basis for all participants.
The core benefits of decentralized finance
- Real decentralization: Helps fight censorship; participation is allowed from all walks of life; and have a trusted third party
- Low costs, fast transactions, and contracts cannot be fraudulent: Thanks to the use of Blockchain infrastructure as the infrastructure
- Users have full control over their assets without the need for a third party: Do DeFi allows users to own private keys
- Increased transparency: Thereby reducing the risks arising from personal interests or false information
How DeFi works
Activity on DeFi is not regulated by any organization or person, but rather rules are written in code or smart contract. When they are deployed on the blockchain, the DeFi dapps operate on their own without any human intervention.
Besides, this smart contract is completely public on blockchain so anyone can audit.
In addition, all transactional activities are also public. However, due to privacy issues, identity on transactions will be recorded with pseudonyms by default.
Can decentralized finance be risky?
When it comes to the level of risk, DeFi dapps are currently the “places” most targeted by hackers. Of all the attacks, the most famous was the DAO that happened in June 2016.
In the incident, the hacker transferred a third of DAO’s funds to another account by exploiting a vulnerability in encryption. This forced the Ethereum community to hardfork the blockchain to recover the lost money.
The most recent major attack is the bZx protocol. Hacker attacked twice in a row and lost nearly 1 million USD.
From there it shows that the technology behind the decentralized financial application is still underdeveloped and has many holes; facilitate attacks, damage the reputation of technology.
Some popular DeFi applications
Decentralized lending platform
There are many different financial products based on DeFi. But, DeFi’s fastest growing and most popular area is its loan and loan platforms.
Similar to banks, users deposit money and earn interest from people who borrow their money. However, in this case, the bank is no longer an intermediary but a smart contract that will be the party connecting the two users; enforce loan terms and distribute interest.
As you know, the cryptocurrency market is one of the most volatile ones; Therefore, there is a need for a coin to hold value, and that is the stablecoin.
Some stablecoins are built on a decentralized financial platform such as: DAI, Terra, True USD,…
Another popular DeFi application is a decentralized exchange (DEX).
DEXs are cryptocurrency exchanges that use smart contracts to enforce rules, perform transactions and securely process funds when needed. Therefore, when you trade on DEX, there will be no transaction operator, no need to verify your identity or lose withdrawal fees.
Some decentralized exchanges: Binance DEX, Huobi Lite, …
There are also a number of other applications such as decentralized payment platforms (Lightning Network, Helis, xDai, …); decentralized derivative products (Market protocol, Uma, …)
Some crypto projects use a decentralized financial system
Currently there are a number of crypto projects that are being built based on DeFi such as: Kava, Matic, UMA, …
Why is the application of DeFi not really popular yet?
This may be because DeFi has yet to overcome the following major hurdles:
As is well known, assets in decentralized finance are in the form of cryptocurrencies. Therefore, the first thing is that cryptocurrencies need to become popular, if DeFi is to be, too
Currently, liquidity in decentralized finance remains low. Meanwhile, liquidity is the key to pricing in the financial industry. As a result, most protocols cannot currently compete with competitors (in CeFi).
Products are excessively mortgaged
Since there are currently no credit scores or general collateral, many products have to be mortgaged in excess (sometimes as high as 150%).
This downside reduces the leverage for professional traders; or the opportunity to gain access to capital that the user does not own.
Risks in engineering
This is one of the issues that most people worry about. If the smart contract or blockchain layer has an error, it is difficult to detect because this technology is still too new.
Besides, by design, false or fraudulent transactions will be irreversible on the blockchain.
Potential in the future
Although still facing many problems, the DeFi ecosystem has grown 15 times over the past two years.
As of February 2020, about 3 million ETH have been locked into DeFi applications. In which, loan products are the fastest growing industry.
That shows that decentralized finance really has a lot of potential. And if the shortcomings can be overcome, DeFi will quickly stand alongside CeFi in the future.
Hopefully, through the above article, you have a clearer view of DeFi. If you have any questions or have suggestions, you can comment below the article.
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