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Who would’ve thought that the global financial system could ever become transparent, permissionless and operate without intermediaries? Well, the decentralized nature of blockchain has become the bedrock for first-class innovations.
As the world evolves every day, new innovations emerge to provide interesting solutions to tackle new challenges. Today in the world of finance, we have technologies and features that are disrupting and overhauling the financial process to boost the efficiency of the financial system.
A lot of people are used to living in the world of centralized finance (CeFi), where users trust people or institutions to rightly manage their funds and carry out services that are being offered by a business. However, this has created many troubling issues for users, such as security and financial risks, due to lack of knowledge about DeFi and the convenient user experience that it offers.
The new face of the financial sector
Decentralized financethe ingenious blockchain innovation is ultimately revolutionizing the financial system from the ground up by offering unique benefits, such as minimizing financial risks like market risks, credit risks and operational risks that affect the current financial sector. Also, the new financial system helps to eliminate the presence of intermediaries in the financial system that is posing a big threat to user security.
In December 2019, research has it that the DeFi ecosystem had less than $700 million worth of digital assets locked in its financial products. Recently, it was revealed that the total value locked in the industry has surged to $4 billion. Statistically, it’s crystal clear that the shift from traditional finance (CeFi) to decentralized finance (DeFi) is the next evolution of the financial system. With DeFi protocols gaining traction in the financial world, a lot of opportunities are opening up to everyone in the financial sphere.
Without a doubt, this new blockchain innovation has taken the financial sphere by storm and has emerged as the most active sector in the blockchain space with a wide range of use cases for individuals, developers and institutions. It offers unique products, such as flash loans, derivatives, permissionless trading and margin calls, insurance and more. As a result of this, many companies are starting to embrace decentralized finance due to its vast dynamism and outstanding features to create solutions needed in the financial sector.
Here are some unconventional ways the transition from CeFi to DeFi is revolutionizing the financial system.
Decentralized exchanges (DEXs)
Decentralized exchanges are crypto exchanges that operate without a central authority while permitting crypto users to transact peer-to-peerborrow from and lend to each other, and also have full control over their funds.
DEXs are facilitated by a system of smart contracts hosted on a decentralized protocol, encoded with a set of instructions with the purpose of autonomously executing exchange orders. This helps to improve security by minimizing the risks, such as hacks, price manipulation and thefts. Meanwhile, advantages of decentralized exchanges over centralized exchanges include the following.
- Increased security by allowing users to control their assets
- New liquidity provision options in automated money markets
- Lower fees through minimal overhead requirements
In fact, billions of trade volumes arise from these DeFi exchanges. According to CoinDesk, September volume on decentralized exchange rose to 103% in 2020 to a record $23.6 billion, which is its third consecutive month of doubling the trading volume from $11.6 billion in August.
Furthermore, DeFi has given rise to unique projects that are organized by some popular decentralized exchanges in the DeFi space like Uniswap, Aave, Kyber and Balancer. DEXs also give token projects access to liquidity without any listing fees, thus eliminating the need for projects to make payment in order to get a token listed on a centralized exchange.
According to the global findex database 2017, it revealed that 1.7 billion people in the world remain unbanked, which means that they do not have access to bank or mobile money. Although there are different reasons for this, with decentralized finance the unbanked could become banked anywhere and anytime with just a cell phone and internet.
DeFi is defined by its open, permissionless accessanyone can access DeFi applications built on Ethereum, regardless of their location and often with no minimum amount of funds required. Hence, it allows people who don’t have access to financial services to take part in the global economy.
Unlike centralized finance, where users are required to provide personal information to a third party know your customer (KYC) process or paperwork before they are given access to services. DeFi allows users to connect directly to services just by using a wallet and without divulging personal information. This helps to reduce to a larger extent the risks of crypto assets being stolen or personal data being used without the owner’s consent.
With DeFi, users do not need to trust and depend on people to manage their funds and carry out services. The blockchain technology helps to build smart contracts with codes that facilitate the actions of intermediaries, including managing and accepting deposits, handling collateralized loans and liquidating collateral assets as per the terms of the contracts should their values fluctuate. Interestingly, the contract codes cannot be terminated or manipulated by any entity and are executed with specific conditions.
Furthermore, users can assess and verify that the smart contracts have been properly built to function as intended by auditing their code and using external tools to determine if a transaction was properly executed.
Interoperability of DApps and tokens is a big advantage to the financial system. Users and developers can easily create their own next generation of DeFi products or services by building on top of existing protocols, customizing interfaces and integrating third-party applications.
For instance, one decentralized app can create a new and unique feature like flash loans, and other DApps can integrate that into their product without asking for permission. In fact, DeFi interoperability has been one of the reasons for the upsurge in the current yield farming, which has led to the recent explosion of the DeFi space.
In addition, the DeFi space is constantly building upon current capabilities and experimenting with new ones. As a result of this, we have an ecosystem filled with groundbreaking financial services.
Clearly, decentralized finance is becoming the most important nascent trend in finance as it creates access to a borderless, open alternative to every financial service, such as savings accounts, loans, insurance, trading and so on.
Paul Igbo is a freelance writer and blockchain researcher. He has over three years of experience providing companies with high quality content that gains social media attention and increases search engine visibility.
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