Historically, finance has been centralized. Governments and banks control the flow of money, can print more whenever they want and prevent people from accessing it. That is changing, though, as decentralized finance (DeFi) begins to take off. Jason Simon, an expert in cryptocurrency, explains why DeFi is the future of finance.
With DeFi, there are no banks – only code that is open to anyone and verifiable by the community. It is censorship-resistant and cheaper than centralized finance, but can still offer all of the same protections.
DeFi essentially consists of three elements – cryptography, blockchain and smart contracts. Cryptography offers the security that prevents outside parties from being able to read the data. The blockchain is the data repository, storing all of the information in a secure, immutable form. The data can never be altered and all of it has to be verified by multiple sources for it to be considered legitimate.
Smart contracts are contracts created on a blockchain and they work similarly to traditional contracts, but better. Explains Simon, “Because there is no way for the data to be altered once included on the blockchain, it is impossible for ownership or terms of the agreement to be questioned. A smart contract is literally the most black-and-white contract that can be created.”
There are five pillars of DeFi. The first centers on stablecoins, digital currency that is matched at a fixed rate to real-world currency. For example, one Tether equals one US dollar. It will always equal one US dollar, regardless of how the dollar moves. Cryptocurrencies like Bitcoin, however, experience fluctuations in their value.
The second pillar of DeFi centers on borrowing and lending. Smart contracts help facilitate loans while maintaining a higher degree of security and anonymity. The fees are significantly lower and it is substantially easier to access cryptocurrency loans than traditional alternatives.
Decentralized exchanges comprise the third pillar of DeFi. Because digital currencies are global assets, they are not impacted by Forex rates or third-party surcharges. Consumers can use their digital assets anywhere in the world without seeing a change in their value.
Insurance, the fourth pillar of DeFi, has a multitude of benefits. An insurance policy can be written based on any number of conditions and caveats. All of those items are constantly verified on the blockchain. Since the policy resides on the immutable blockchain, there is no way to alter the data. If a claim is placed, it can be almost immediately verified for payment, instead of having to wait for months, or years, as is currently necessary with most insurance policies.
Margin trading is the fifth and final pillar of DeFi, but offers a range of benefits to consumers and investors. Again, because of its reliance on the blockchain, it becomes infinitely easier to participate in margin trading at virtually no cost. Trading conditions are automatically updated and, once met, the expected response will instantly kick in. This saves valuable time and helps maximize the investment to its fullest.
DeFi offers a world of benefits for the future of finance. It has begun to receive more attention in the past couple of years, but still has a long way to go. This is because it is fighting conventional thinking that centralized finance is the only possible solution. However, as more people realize the advantages of DeFi, this is going to change.