What is DeFi
29th September 2020
The decentralized finance market or DeFi is the fastest-growing segment of the crypto industry today. The number and growth rate of DeFi projects reminds of the ICO boom in 2017. Three years ago most new projects were not practical and were almost identical. But DeFi startups create effective alternatives to traditional financial instruments. Let's take a closer look at the DeFi concept, as well as the prospects and problems of the decentralized finance market.
How DeFi Works
DeFi is a movement whose goal is to create an open, free, transparent, and accessible system of financial instruments for every user, which will not depend on banks and states. In such a system, each participant has full control over funds and assets. Users do not have to use the intermediaries' services, which will significantly save money on commissions. The following services already exist on the DeFi market:
A service that allows some users to borrow any amount of funds, while others can lend money and receive interest from it. There is no external regulation in the system. Instead of credit history, the borrower's creditworthiness is based on an internal rating. The more loans the user repaid, the more amount he can borrow.
Decentralized Financial Markets (DEX)
To trade on usual financial markets, users have to ask for brokerage companies services, pay a commission, and risk their funds, as the broker may turn out to be a fraud or go bankrupt. You do not need a broker to access trading on a decentralized exchange. You just need to register an account.
Casinos, totalizers, and other entertainment services are prohibited in many countries. Besides, when betting, you run the risk of becoming a victim of fraudulent schemes. However, if the gambling platform is decentralized, you don't have to worry about losing your funds through the company's fault.
Issue of Electronic Securities
If it is possible for an exchange to exist without brokers, then it is possible to issue shares without the participation of investment banks. Tokenized securities are similar to classic securities. Their value is ensured by real value (share in the company, government reliability, etc.). DeFi simplifies the process of issuing and distributing securities and makes it secure.
Assets management is similar to ETFs investing. You can invest your funds in tokens, the cost of which depends on the rate of several cryptocurrencies. It allows us to diversify the portfolio with less money.
DeFi Market Risks
Despite the impressive list of advantages, DeFi projects have several disadvantages, including:
- The threat of hacking smart contracts
At the heart of any DeFi project is a smart contract system that ensures the correct execution of all services. However, like any program, smart contracts can be hacked if the developers do not provide the proper level of security.
- Lack of funds
It is a significant disadvantage of DeFi services comparing to classic banking services. It is impossible to get a large loan in a DeFi project since the other participants do not have such funds.
- Risk of volatility
DeFi systems are backed by cryptocurrencies, which are quite volatile. The BTC rate fall entails a drop in the rates of all tokens and, in the long term, their depreciation.