A lot has changed in the world of finance in recent years. The traditional bank loan has become harder to attain and start-up businesses have begun to look for alternative methods of raising funds.
The emergence of cryptocurrencies has brought new avenues to those looking for funding, and the new word on the block is DeFi – decentralized finance.
What’s it all about, and why do you need to know about it? Let’s start by explaining what DeFi is and we’ll talk about its potential.
What is DeFi Lending
In a nutshell, decentralized finance is about transacting finance in trustless and transparent manner.
For millennial generations Y and Z, banks, brokers and other lenders might no longer be the places to go for loans. Instead a borrower might look to decentralized peer-to-peer lending platforms to provide loans in fiat-backed stable currencies.
Decentralized stable currencies pegged to the US dollar on lending platforms have been around for a while. Decentralized Euro-pegged lending platforms are now only beginning to make inroads in the DeFi lending scene.
These platforms are managed by Smart Contracts and connect lenders and borrowers directly, not requiring centralized intermediaries like banks to implement the lending. The P2P services are for both the public as well as businesses.
Easier Access, More Attractive Rates and Zero Privacy Woes
There are obvious benefits to this democratized way of transacting. Both borrowers and lenders benefit from easier access and more attractive borrowing and lending rates since there are no middleman fees. The slow processing times associated with traditional bank loans are now no longer a cause for concern. Anyone can also take out a loan without ever having to disclose personal data.
Lenders send the tokens they wish to lend into a ‘money market’ that utilizes a smart contract serving as an automated digital intermediary which issues interest in the platform’s native token. Borrowers lock supported collateral in order to borrow (or mint) these tokens which can then be used in the DeFi marketplace.
In traditional finance, it is common to use fixed deposits, where we deposit funds in the banks for certain periods of time to earn interest. However, in the DeFi space, this is known as staking and the APY’s are higher and the entry barriers to participation are lower, thereby offering a more attractive value proposition.
Why DeFi is the Future
Is DeFi here to stay? We believe it is and there are several reasons why.
The DeFi industry is young – as is the cryptocurrency world – but is rapidly making inroads with technological improvements and offering up more stable financial services, while continuing to emphasize transparency and privacy, two factors that generations Y and Z tend to value.
However, to really sum up why DeFi is the future of lending, it can be whittled down to one thing – DeFi uses blockchains.
This technology grew out of cryptocurrency – with Bitcoin leading the charge – but has been accepted more broadly across industries for its plethora of use cases.
Simply put, a blockchain is a database shared across a network of computers (nodes) which makes any records on the blockchain difficult to tamper with since the entire network would have a copy of them. This immutability feature is priceless when it comes to implementing value transactions since all transactions recorded on the blockchain are transparent and designed to be tamper-proof.
When you utilize blockchain protocols such as Ethereum, the leading blockchain network in DeFi, you are trusting cryptography, a combination of math and randomization to enact transactions in a decentralized manner across the network.
As Vitalik Buterin, founder of Ethereum, puts it, “Whereas most technologies tend to automate workers on the periphery doing menial tasks, blockchains automate away [from] the center. Instead of putting the taxi driver out of a job, blockchain puts Uber out of a job and lets the taxi drivers work with the customers directly.“
In DeFi lending, there is thus no centralized lender required and the agreed-upon interest and other terms of the loan are enforced automatically by smart contracts. We can finally kiss counterparty risks goodbye as no one can alter the smart contract once it’s live – it will run as programmed.
Putting the Control of Your Finance Back to You
Since smart contracts are public on the blockchain, this also means that bad contracts can come under community scrutiny. The community helps to keep developers and projects in check. However, it is still of paramount importance when you first select your lending platform to do the necessary research to make sure that the developer teams behind these platforms are established in the industry. Why?
Bad code can result in a loss of funds or expose the platform to hacking opportunities. Hence, reputable platforms usually undergo third-party audits as proof that the platforms are ‘functioning as intended’.
If this all sounds rather ‘cloak and dagger’, it is because the idea of cryptocurrencies is still new. This is certain to change in the near future as more transactions are performed this way and increasing numbers of businesses and individuals get involved in cryptocurrencies.
In the meantime, it really does become a lot simpler once you familiarize yourself with the core concepts and start getting hands-on. Which really makes sense to do once you realize that DeFi is basically putting the control of your finance back into your own hands.